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Ci)PMRIGHT DEPOSm 



PROFIT AND WAGES 



PROFIT AND WAGES 

A STUDY IN THE DISTRIBUTION 
OF INCOME 



BY 

G. A. KLEENE 

PROFESSOR OF ECONOMICS, TRINITY COLLEGE, HARTFORD, CONN. 



THE MACMILLAN COMPANY 
1916 



^v^ 



Copyright, 1916, 
By the MACMILLAN COMPANY. 



Published November, 1916. 



DEC -7 1916 



3CI.A446884 

7 / t i : 



PREFACE 

Though its abstract and intricate character has 
made it an esoteric discipline, the theory of distribution 
demands the consideration of every serious student 
of affairs. No fundamental conception of our most 
important economic problems is attainable except in 
relation to the factors governing the distribution of 
income. Unless resigned to superficial views, we cannot, 
therefore, maintain a passive attitude toward the 
unsettled state of economic doctrine. In the face of 
continued failure, neither discouragement nor scepticism 
should halt the struggle for a definite and accepted 
theory of distribution. May the publication of this 
book contribute something to the will to master the 
difficulties of the problem. 

The author is under obligation for permission to 
use parts of an article published in the Quarterly Journal 
of Economics for February, 191 2. He is also under 
great obligation to his wife for criticism and assistance 
in revision and proof-reading, and to his friend, Mr. 
Edward Porritt for helpful counsel. 



TABLE OF CONTENTS 

Chapter I. Introduction. 

Definitions of distribution and income, i. Concept of 
psychic income not of service to present inquiry, i. Differ- 
ences in method of investigation according as the subject 
is the distribution of wealth or the distribution of income, 
2. The method of economic theory, 3. Hypothetical 
assumptions to be made and limitations of our inquiry, 5. 
Reasons why our inquiry must be largely critical, 7. 

General Outline of Subject — The parties who share 
in the total product of society, 8. Different concepts of 
capital, 9. Capital regarded as subsistence advanced to 
labor the most fruitful concept for the theory of distri- 
bution, II. Distinction between differential and marginal 
income, 13. First stage in our analysis of distributive 
process the separation of differential gain from marginal 
income, 15. The second stage the division of marginal 
income between capitalist and laborer, 16. Three different 
methods by which it has been attempted to explain this 
division, 18. 

Chapter II. Bohm-Bawerk's Theory of Interest. 

Reasons for beginning a critical study of the problem 
with Bohm-Bawerk's theory, 20. Bohm-Bawerk's funda- 
mental concept, 21. Three reasons for preference for 
present over future goods given by Bohm-Bawerk, 22. 
The technical superiority of present good no direct ground 
for preference for present goods but possibly an indirect 
one, 25. Bohm-Bawerk failed to give a unitary explanation 
of interest, 28. 

Chapter III. The Time-Preference Theory. 

■ Attempt to base interest theory on first two grounds of 
preference mentioned by Bohm-Bawerk, 29. Do these 
play an actual part in saving and investment? 30. Defini- 

I 



TABLE OF CONTENTS 

tion of time-preference, 33. Transition from earlier idea 
of abstinence to that of time-preference, 35. No post- 
ponement of consumption of capital in actual investment, 36. 
Is there an exchange of present for future goods? 39. A 
less objectionable form of time-preference theory, 43. 
The consumption loan, 45. The purchase of durable 
goods not explained by time-preference theory, 46. The 
reductio ad absurdum of the time-preference theory, 47. 
Sceptical reaction against theories based on subjective 
valuations, 49. Excessive rationalism of time-preference 
theory, 51. Time-preference not a direct determinant 
of the rate of interest, 53. 

Chapter IV. The Abstinence Theory. 

The abstinence theory treats only of supply of capital 
and does not give a complete explanation of the income 
of capital, 55. Accumulation of capital without subjective 
cost, 56. Idea of marginal savings, 57. Ambiguities of 
a formulation of the theory in terms of demand and supply, 
59. The two fundamental propositions of the theory, 61. 
Criticism of idea that changes in supply of capital regu- 
lative of rate of return are brought about by marginal 
savers, 62. Prime factors determining supply of capital 
are objective, not subjective, 68. Supply of capital, on 
the whole, tends to rise with increase in rate of return, 70. 
Does not decrease as rate of return declines, 71. Factors 
which prevent extinction of capitalist income, 73. Only 
extreme changes in rate of interest affect determination 
to save, 75. Theory of rate of capitalist income must 
emphasize objective factors, 77. Does abstinence theory 
explain existence of interest? 79. 

Chapter V. The Productivity Theory of Interest. 

The specific productivity theory, 82. Difficulties of 
imputing a specific product to capital, 82. Vicious circle 
in deriving value of capital goods, 85. Productivity theory 
does not show how interest on sums spent for wages is 
derived, 87. Difficulties growing out of concept of capital 

II 



TABLE OF CONTENTS 

and restricted view of productive process, 87. A form of 
productivity theory suggested by Bohm-Bawerk and 
Landry, 92. The assumption of a normal lack of capital 
made by this theory, 94. The theory at bottom almost 
the same as the specific productivity theory and encounters 
similar difficulties in determining value of capital invested, 
95. Importance of the theory, 97. 

Chapter VL The Essentials of a Theory of Profit and 

Interest. 

Relation of four quantities (gross income, net income, 
rate, and capital) expressed in two equations, 99. None 
of theories so far examined has explained, or is justified 
in assuming as accounted for, more than one quantity, 100. 
Necessity of accounting for value of capital independently 
of amount of product or rate of profit, loi. Capital consists 
of wages, and profit of capital is a residual income, 102. 
Name to be given to our theory, 105. What prevents fall 
of prices from extinguishing share going to capital? 108. 
What keeps labor from getting entire marginal product 
of industry? 109. How is surplus value growing out of a 
series of processes controlled by different entrepreneurs 
distributed at a uniform rate to every part of investment 
made by each entrepreneur? no. Theory here proposed 
assumes as given factors transmitted from pre-capitalistic 
times, 112. 

Chapter VII. The Theory of Wages. The Supply of 
Labor. 

Relation of theory of wages to theory of income of 
capitalist, 114. Wage theories which might form basis of a 
residual claimant theory of profit and interest, 115. Mal- 
thusian basis of subsistence theory, 116. Relation between 
standards of living and wages, 117. Arbitrary character 
of assumption of a natural wage, 118. Marx's criticism 
of subsistence theory, 119. Immigration a disturbing 
factor, 119. Need of a theory of demand for labor felt 
by classical economists, 120. Rise of standard of living 
of wage-earners and its bearing on subsistence theory of 

III 



TABLE OF CONTENTS 

wages, 121. Conditions under which subsistence theory- 
has some validity, 122. How supply price of labor is 
determined, 124. Why geographical differences in wages 
correspond to differences in productivity, 126. 

Chapter VIII. The Theory of Wages. The Demand for 
Labor. 
The wages fund doctrine suggests a collective exchange, 

128. Necessity of laborer and employer coming to terms, 

129. Does possibility of substituting machines for labor 
show that there is no definite wages fund? 130. Under 
static conditions and when production period of maximum 
efficiency has been reached, there is a definite wages fund, 
133. Bohm-Bawerk's wages fund theory, 135. Is wages 
fund capable of quick expansion? 137. When viewed as a 
money fund, 138. When regarded as real income, 139. 
The bargain theory of wages, 141. Wages fund theory 
only possible explanation of general level of wages, 142. 

Criticism of Productivity Theory of Wages — 
Erroneous assumption in regard to expansibility of demand 
for labor, 144. Productivity explains comparative wages 
only, 146. Can wages be paid out of current product? 149. 
Productivity determines wages only by its influence on 
the accumulation of capital, 151. Wages not determined 
by discounted product of labor because there is no rate 
of discount established independently of level of wages, 153. 
Criticism of productivity theory on ground that specific 
product of labor is not ascertainable, 155. 

Conclusion — General level of wages is determined by 
size of wages fund and the supply price of different quan- 
tities of labor, 157. 

Chapter IX. Conclusion. 

The two stages in our analysis of the problem of dis- 
tribution, 159. Criticism of the concept of capital as 
including land, 160. Criticism of the "law of three rents," 
160. Summary of conclusions reached, 163. The return 
to the classical school of economists, 164. Unfortunate 
tendencies of modern economic theorizing: (i) Excessive 
rationalism, 166. (2) Confusion of problem of distri- 
bution with that of value, 167. 

IV 



PROFIT AND WAGES 

CHAPTER I 

INTRODUCTION 

In the meaning usual to economic literature, 
distribution is division into parts and the appor- 
tionment of the parts to those who share in 
the division. Now it is the distribution of in- 
come rather than of wealth with which we are 
here concerned. Income is wealth just pro- 
duced or come into existence. It should be 
thought of as a stream and measured by its 
volume per unit of time. Taking the collective 
view essential to the science of economics 
the problem becomes that of the division of 
the total income or produce of human industry. 
We are to explain how the flow of goods from 
mine and farm and factory spreads and divides 
into streams of private income, — into the 
rent, profit, and interest, for instance, which 
falls to the well-to-do, or the wages with which 
the poor must be content. 

As the ultimate significance of these streams 
of goods is in the uses made of them, one might 
regard income as consisting of the feelings of 
the consumer of goods rather than of the goods 
themselves. But such a conception of income 
would not serve the purposes of the present 
inquiry. "Psychic income" is too remote from 



2 PROFIT AND WAGES 

the problems with which a study of distribution 
must begin. The amount of utihty derived 
from equal quantities of any commodity varies 
widely as between different consumers and 
even between different times and conditions 
for the same consumer. The final determina- 
tion of psychic incomes, therefore, lies in the 
process of consumption. It comes at a later 
stage than that of distribution.* 

Income is measurable only as a rate, as 
amount per unit of time. The total of wealth, 
on the other hand, cannot be measured otherwise 
than by taking the quantity existing at a point 
of time. As such it would include the income 
of the moment but also the wealth which has 
arisen or come in at previous times and which 
still remains unconsumed and undestroyed. 
When referring to income, the term distribution 
evidently denotes a process. When applied 
to wealth, however, it means the result or out- 
come of a process of distribution, or of a series 
of such processes. The method of investigation 
must differ according as the object of inquiry 
is the process or the result. To picture the 
result, the distribution of wealth at any point 
of time, the only satisfactory method would be 
the statistical. If complete data were available, 
the statistician could tell us how many rich 
men there are and what is their wealth, and how 

*A very satisfactory discussion of income thought of as a stream 
of goods can be found in Lexis, Allgemeine Volkswirtschafts- 
lehre, p. 137 ff. 



INTRODUCTION 3 

many poor there are and what is the depth of 
their poverty. The explanation of how this 
distribution came about would constitute an 
historical problem. It is not, however, the 
object of the present essay to describe and 
explain the distribution of an existing stock of 
wealth. Our problem is the complicated process 
of parcelling out the newly produced wealth or 
income of society. In the analysis of such a 
process statistics and history can give little 
aid. At least in the initial, and most difficult 
stages, of the inquiry, the method of "theory" 
alone is of service. 

This is the method of mental experiment 
with different lines of approach to the problem, — 
the exploitation of different facts and ideas as 
tentative premises. The forces of our indus- 
trial system are so involved that no conception 
of its operation could be reached by any attempt 
to describe its details. In fact the more photo- 
graphic and concrete the picture presented to 
the mind, the more confusing and difficult 
the problem becomes. The only feasible pro- 
cedure, therefore, is to seek for essential facts 
and to reason from these, while deliberately 
excluding from view a mass of complicating 
phenomena. Intellectually portable and man- 
ageable results are won by selection only. Com- 
plications must be eliminated, or, in other 
words, hypothetical assumptions must be made. 
Economic theory differs from other sciences 
only in the degree of its hypothetical character. 



4 PROFIT AND WAGES 

But for use in practical affairs or to satisfy a 
mental craving for a more concrete picture of 
the world, our first simplified, hypothetical, 
general theory may be subjected to a series of 
qualifications by bringing in one by one the 
complicating conditions which had been ex- 
cluded at the beginning. Thus a series of prop- 
ositions may be reached which, descending 
into ever greater detail, lead us by successive 
approximations* to a closer view of things as 
they are. How closely we desire to approxi- 
mate the confusing reality of our industrial 
life, or at. the other extreme, how far we are 
willing to carry the process of abstraction to 
gain a general view, depends largely on our 
mental constitution. It is not altogether flippant 
to call it a matter of taste. In the end, however, 
the use we intend to make of our theories may 
decide to what degree of abstraction from or 
approximation to the complexities of the actual 
world we may safely proceed. 

*The idea of " successive approximations," a metaphor derived 
from physics and mathematics, has perhaps received its vogue 
especially from Pareto (Cours d'economie politique, p. i6 ff.). 
Graziani {Instituzioni di economia politica, p. 45) attributes 
the use of the term especially to Pareto and Barone but says 
that the method itself goes back to the classical writers such 
as Smith, Ricardo, and the two Mills. It has probably been 
used more or less deliberately by many writers. The opening 
paragraph of the third volume of Das Kapital, for instance, 
shows Marx making conscious use of this method. The mention 
of Marx suggests the dangers and difficulties of beginning 
with assumptions too remote from reality. A recent instance 
of a start too remote from reality, in the present writer's opinion, 
is that made by Schumpeter ( Theorie der wirtschaftlichen 
Entwicklung.) 



INTRODUCTION 5 

It follows from what has just been said that 
the general theory of the distribution of income 
aimed at in the following pages must submit to 
certain limitations. To state some of these, 
(i) it must confine itself to what may be called 
the primary process of distribution, the dividing 
up of the product of industry among the parties 
immediately connected with the productive 
process. In other words, our problem is that 
of wages, interest, profit, and rent. How 
secondary incomes are derived from these pri- 
mary shares through gift, theft, begging or 
taxation, need not concern us. Profits or other 
incomes from business operations which are 
not productive or whose relation to production 
is remote and uncertain must also be omitted 
from consideration. Various "pecuniary" em- 
ployments of capital, as Veblen would call 
them, — speculative manipulations, for instance, 
— for all their spectacular interest and dis- 
turbing significance, must be excluded. To get 
a clear view of the fundamental factors, our 
study must stick closely to the process of 
production and to those classes which draw 
their living immediately from that process. 
(2) Our study must assume the prevalence of 
competition. At a time of widespread appre- 
hension of the growing power of large aggre- 
gations of capital, this assumption may appear 
to lead to conclusions somewhat too remotely 
connected with contemporary conditions. How- 
ever the extent of the monopoly exercised by those 



6 PROFIT AND WAGES 

to whom popular opinion attributes this power 
is somewhat in doubt and certainly their 
power is not absolute. The mixture of com- 
petition and monopoly in the industrial life of 
today cannot be understood unless we have a 
clear conception of the workings of a competitive 
system. For the purposes of our theory it will 
be well, therefore, to set aside monopoly as a 
disturbing factor acting upon a fundamentally 
competitive order. In other words we reach a 
"first approximation" by assuming a competitive 
system. (3) Another limitation to which our 
theorizing must submit is in the historical 
range of its application. It is confined to 
present conditions, to the "system of industrial 
liberty," to "capitalism." Starting from facts 
and conditions of the present it may not asstime 
universal validity for its conclusions. On the 
other hand it is under no necessity of accounting 
for the origin and evolution of economic insti- 
tutions which our industrial system has inherited 
from the past. It may take their existence for 
granted, asking only how they affect the quantity 
of income going to the different "shares in 
distribution." 

The foregoing limitations are observed 
throughout this book. Other assimiptions will 
be made from time to time to save the argu- 
ment from unnecessary complication. Although 
these are not always explicitly mentioned, we 
trust they will be reasonably obvious to the 
reader and will be such as experience has shown 



INTRODUCTION 7 

to be necessary to the operations of economic 
theory. The results reached by the method 
pursued are necessarily propositions of an 
abstract character. To the type of mind that 
hungers for graphic and abundant detail they 
may appear very unsatisfactory. But our 
present aim is an analysis of the industrial 
world, not photography, and so no other course 
lies open. 

To find the starting points for an analysis 
of the distributive process it will be prudent to 
examine the results of the mental experimen- 
tation of leading thinkers in this field. The 
stock of facts and ideas with which theory 
operates is selected from a complex reality 
largely in the form of general impressions of 
what may prove significant. A review of the 
impressions of able theorists as to what elements 
enter into the determination of the shares in 
distribution, and of the failures and successes 
of the different theories set forth, is the only 
sure precaution against making a false start. 
Our work then must be largely critical. That 
to save time the discussion is restricted to 
theories which still have some standing in 
scientific controversy will, we trust, commend 
itself to the approval of those competent in 
economic studies. But before entering into 
the necessarily technical, and perhaps confusing, 
detail of a critical study, it may be well for the 
sake of perspective to offer the reader a general 



8 PROFIT AND WAGES 

sketch of the field we are to enter. This is the 
purpose of the remaining pages of this chapter. 

The classical economists represented the 
national product as divided among landowners, 
capitalists, and laborers — three rather distinct 
classes in the social life of the England of their 
day. A fortunate tradition for the theory of 
distribution was thus established by an historical 
accident of time and place. Had the owners of 
capital and those of land been merged as com- 
pletely as they were in some countries and as 
they are in the England of the present time, 
economic theorists might have failed to isolate 
the share in distribution that falls to the land- 
owner as such. A part, at least, of what goes 
under the popular term of rent of land, has 
important characteristics which distinguish it 
from the income of capital. As will soon appear 
it is a differential gain of a rather permanent 
character. Not to recognize this would seriously 
distort our picture of the distributive process. 
In the writer's opinion, it was fortunate also 
that economists did not at once make and 
emphasize the distinction between capitalist 
and entrepreneur, which later came into fashion. 
The capitalist is lender and investor only of 
capital, the entrepreneur user of it. To an 
increasing degree the entrepreneur is coming 
to be not an individual, but a group of men, 
a corporation. It will be convenient, however, 
throughout most of our discussion to think of 



INTRODUCTION 9 

him as an individual business manager. So 
conceived, he is the one controlHng and directing 
the process of the production of wealth. The 
products are his until he sells them. If they are 
unsaleable, the loss is his. He may be capitalist 
and landowner besides being entrepreneur. In- 
deed, he usually owns some capital. Out of 
the process of buying, borrowing, and hiring 
for his business, and the sale of the products, 
he gets his profit. To the landowner he pays 
rent, to the capitalist interest, to the laborer 
wages. The problem for the theory of distribu- 
tion is, what determines the amount of each 
of these shares in distribution — rent, interest, 
wages, and the entrepreneur's profit. 

Confusion enters into this controversial 
matter at the very outset, through the failure 
to agree upon some distinct concept of capital. 
What is this thing whose ownership gives the 
power to get an income without labor, or in 
other words, to levy on the labor of others? 
Popular terminology is indefinite and shifting. 
One meaning suggested by it, that of capital 
as a sum of money is obviously inadequate for 
our inquiry. Even if it were permissible either 
to overlook bank credit or to regard it as a 
kind of money, this popula-r concept would be 
too superficial. It is what is bought with the 
money by the managers of productive enter- 
prises that makes it effective in securing an 
income and, which, therefore, constitutes the 
true capital. It will be advantageous at least 



lo PROFIT AND WAGES 

in our first approximate formulation of the 
theory of distribution, to forget the existence of 
money and to think of commodities and services 
as exchanged by barter, though with a celerity 
and ease not possible to that crude method of 
exchange. 

Passing from popular usage to that of the 
more scientific literature of economics, we meet 
a discouraging diversity of opinion. In general, 
however, there are two tendencies. One is 
to regard capital as a sum of value, the other 
as consisting of concrete goods of some kind. 
To consider capital as value (or as a sum of 
prices) instead of using value or price merely 
to measure a quantum of capital, gives a con- 
cept useful only to one theory of interest, the 
time-preference theory, and not acceptable, 
therefore, unless that theory can be accepted.* 
Of course the concept is also useful to the book- 
keeping or accounting of private and individual 
economics {Privatwirtschaft). Our aim, how- 
ever, is not to describe the individual's method 
of measuring his gains, but to explain the 
source and amount of income that goes to the 
owners of capital as a class. 

*Professor Clark employs a concept of this kind in connection 
with a productivity theory. Obviously, however, it is the 
concrete "capital goods," which he distinguishes from the 
fund of capital or capital proper, which really aid production 
and constitute the basis of the capitalist's income, not the 
abstract fund or collective value of these goods. See remarks 
by Carver in Quarterly Journal of Economics, May, 1907. 
See also the trenchant criticism by Bohm-Bawerk ibid., 
November, 1906, and February, 1907, and by Veblen ibid., 
February, 1908. 



INTRODUCTION ii 

Of definitions of capital as concrete goods 
there is a considerable variety but two may be 
taken as dividing between them a large part 
of the usage of economic literature — one, that 
of capital as consisting of "intermediate goods" 
or goods produced to be used in further pro- 
duction; the other, as subsistence maintaining 
labor in the long process of production, and 
advanced to the laborers out of past product 
by the capitalist class. Which of these is to 
be preferred can be decided only when we 
inquire what each leads to when used as a basis 
for a theory of interest. Some reasons will be 
given at this point for choosing the view of 
capital as subsistence advanced to the laborers. 
The chief purpose of these remarks, however, 
is not to dispose definitively of the question of 
the proper definition of capital, but to give the 
reader the background of a general picture 
of the production and distribution of wealth. 

If capitalists as a class enjoy a peculiar income, 
that income must in some way be traced to 
the peculiar contribution made to the pro- 
ductive process by capitalists as a class. To 
this contribution it would seem appropriate 
to give the name capital if that trouble-breeding 
term is to be used at all.* Now what capitalists 

*Something might be said in favor of dropping the term alto- 
gether from economic theory because of the confusion it has 
always caused. The dreary debate about its proper meaning 
has had the advantage of estabhshing in our terminology a 
number of convenient names for proposed claimants for the 
title of capital, e. g., intermediate goods, producers' goods, 



12 PROFIT AND WAGES 

as a class contribute is the subsistence of the 
laborer or wages (that is real wages). This 
appears when we consider the entire process of 
the production of any consumable commodity, 
viewing it as beginning with the first labor 
employed to make any instrument or material 
used in the course of the long process. Pro- 
duction is then seen to be simply the use of 
labor power on the physical world. The process 
of making any commodity may be, and usually 
is, divided into different stages, controlled by 
different entrepreneurs. The latter contribute 
the labor of scheming and directing, but the 
capitalists, or the entrepreneurs in so far as 
they are capitalists, contribute nothing but the 
wages paid to the laborers.* This is the one 
investment of capitalists as a class with reference 
to productive enterprise. The "capital goods" 
such as machines, raw material, etc., which 
appear in the productive process, are bought 
by one capitalist or entrepreneur from another. 
The purchase and sale of these products or 
intermediate goods, however, is a purely intra- 
class affair. Such purchases and sales are a 

consumers' goods, durable goods. The use of these terms in 
place of the ambiguous word capital would clarify many 
economic discussions. 

*Our reason for not mentioning the rent of land among the 
payments made by the capitalist will soon appear (page 15S.). 
Taxes may also be disregarded. We may think of them as 
paid out of income and, in any case, as having no necessary 
direct relation to the process of producing and distributing 
wealth. 



INTRODUCTION 13 

means of dividing up between different capital- 
ists the capital investment necessary in the 
long process of producing any consumable 
commodity. The buyer of a machine for 
instance, pays the seller the wages the latter 
had paid in having the machine made. As the 
price of the machine, however, also includes 
interest and profit to the seller, the purchase 
and sale of such "intermediate goods" also 
appears as means of dividing up the profits 
and gains of capital of the entire productive 
process. But these transactions within the 
class of capital owners constitute no part of 
the necessary contribution of the capitalist 
class to the process of production. The necessary 
contribution of this class, the investment from 
which it derives its income, the mysterious 
thing called capital, consists of the subsistence 
or "real wages" given the laborer. For the 
theory of distribution at least, this seems the 
most fruitful conception of capital. 

And now we return to the question asked a 
few pages back as to what determines the amount 
of each share in distribution — of rent, interest, 
profit, and wages. In the attempt to give a 
preliminary sketch of the questions at issue, 
we may start with an idea which has come 
very near to having gained universal acceptance 
among economists, and make it the background 
for a formulation of the principal contending 
theories. This idea is that of a distinction 
between differential and marginal income. The 



14 PROFIT AND WAGES 

productive result of the investments made by 
capitalists and entrepreneurs varies widely. 
Any return in excess of the lowest or marginal 
rate of productivity is a differential gain, and 
may take the form either of rent of land, or 
of differential profit. The most permanent 
differences in productivity are inherent in the 
quality and location of the land which is used. 
Less stable differences may be traced to the 
differing abilities and luck of the entrepreneurs. 
As the capital of the world increases, entre- 
preneurs proceed to less and less productive 
investments — assuming that they first took 
advantage of the best opportunities. The 
course of investment is from more to less 
productive lands and locations, stopping at 
successive "extensive margins," and also from 
more to less productive investments on the 
same land, according to the "law of diminishing 
returns," making successive stops at "intensive 
margins."* On the assumption of perfect 
mobility of capital, a given total of capital 
will be so distributed in its investment as to 
establish a uniformly productive margin along 

*The law of diminishing returns from land will hold, that is 
there will be an increase of total product but a diminished 
product per unit of investment, if the additional "capital" 
invested takes the form of, or results in, an increased appli- 
cation of either labor or capital goods to the land. As will 
appear later, it is possible that an increased supply of capital 
may bring about nothing but an increase in the rate of wages. 
In that case, of course, there is no increase of either total or 
marginal product. The relative shares received by capital 
and labor will be changed, but there will be no change in the 
differential gains. 



INTRODUCTION 15 

both the extensive and intensive frontier. Addi- 
tions to the supply of capital can then be invested 
at the margin only, and get only the marginal 
rate of return — unless they can displace capital 
at other points. The competition of this new 
capital with the older supplies which it is 
capable of displacing, tends to make the marginal 
rate the rate of return for all capital, by giving 
the landowner the power to demand all in 
excess of this (except the "ability rent" of the 
superior entrepreneur) as a rent.* At the 
outset, of course, the entrepreneur receives the 
entire product, but the destination of all the 
differential gain, the surplus over the marginal 
rate of return, is apparent. 

We may thus view the problem of distribution 
as being, at the first stage, a question between 

*The rate of "productivity" of capital at the margin would 
vary according to the ability of the entrepreneurs managing 
it. A marginal rate, therefore, if it is to be something definite, 
implies a marginal managerial ability. The amount of capital 
(and consequent size of business) controlled by different 
entrepreneurs tends to vary according to their ability and 
energy, the least competent of the entrepreneurs able to 
maintain themselves against competition, the marginal entre- 
preneurs, controlling the smallest business units. This on 
the assumption, very far indeed from being fully justified by 
the reality, that the control of capital is distributed according 
to ability and not by accident and favor. Because of the 
advantages of large scale production, those able to manage 
large amounts of capital will get a higher rate of return than 
the marginal entrepreneur, a differential profit, even for their 
marginal investments. The marginal rate pays only interest 
and "wages of management" to capitalist and entrepreneur, 
but the abler entrepreneurs get more than this rate. Even 
under static conditions, therefore, there is a differential profit 
graded roughly according to the ability of the entrepreneur. 
Under dynamic conditions, there are also the temporary gains 
that come to the alert, progressive, and lucky ones. 



i6 PROFIT AND WAGES 

entrepreneur and landowner. Whatever the 
productive forces appHed to the land, they 
represent capital investment to the entrepre- 
neur. When they yield a surplus above the 
marginal rate, this becomes either the rent 
of the landowner or the differential profit of 
the entrepreneur. But this division between 
differential and marginal income is not the 
whole of the distribution to be made. The 
entrepreneur has also to deal with the laborer 
and the question then becomes that of dividing 
marginal income, the product remaining after 
the subtraction of the differential gains. Here 
we reach the questions most in controversy. 
The fact of differential gains is pretty well 
acknowledged, however much economists may 
disagree in regard to its different aspects. 
But on the problem of the division of the 
"marginal product" between capitalist and 
entrepreneur, on the one hand, and the laborer, 
on the other, there are the most persistent and 
irreconcilable differences of opinion. A dis- 
cussion of the theory of distribution inevitably 
must deal chiefly with the controversies over 
the character of the apportionment of the 
marginal product between capital and labor. 

A diagram may be used to show the relation 
between differential and marginal incomes. Let 
the figure CAED represent the total product 
of industry. Distance from line AE measures 
productivity and distance along AE'ih.e quantity 
of capital invested. DE indicates productivity 



INTRODUCTION 



17 



at the margin, and CBD the total of differen- 
tial gains (rent and differential profit). The 
controversial problem for the theory of distribu- 
tion is that of accounting for the division of 
ABDE between labor and capital.* 
c 



Differenticl 



Return to capital 



Return to labor 



Holding throughout the point of view gained 
by setting aside rent and some profits as differ- 
ential and concentrating our attention on the 
division of the marginal product and the rates 

*The diagram is constructed with reference to illustrating the 
quantitative aspects of the division of the total product rather 
than the source of each share. It would be misleading if it 
suggested that labor and capital get their return from the 
same monthly or annual product. If capital gets its return 
from current product, then wages must be thought as paid out 
of earlier product. The rectangle ABDE should really be 
interpreted as that part of the gross income of the entrepreneur 
left after deducting rent and differential profit, and the portion 
marked "return to labor" as the equivalent of the wages 
which have been paid. 

For the sake of a simplified statement no mention is made 
above of non-differential profits, or what are sometimes regarded 
as "wages of management." Some writers would merge 
them with the return to capital as part of the "profit of capital" 
{Kapitalgewinn); others would merge them with wages as 
payment for labor. Reasons for giving our preference to the 
former alternative will appear later. 



i8 PROFIT AND WAGES 

of interest and wages thus established, we may 
mention briefly some of the principal attempts 
to explain the division of product between 
capital and labor. 

One method of explaining the existing division 
of ABDE is to find a factor determining one of 
the two shares independently of the other and 
of the amount to be divided. This leaves the 
recipient of the other a "residual claimant." 
Ricardo, for instance, describes the share going 
to labor as determined by the cost of the laborer's 
subsistence according to some more or less 
fixed standard of living. The remainder of 
the marginal product would then constitute 
"profit of capital." Or, on the other hand, 
wages may be made to appear a residual income 
by representing the return to capital as deter- 
mined by some subjective factor such as cost 
of abstinence or waiting, or by the degree of 
preference for present over future possession. 
A favorite variant of the theory appears when 
wages are spoken of as the discounted marginal 
product, the rate of discount being set by 
the "rate of time-preference." 

Another method of explaining the division 
of the marginal product is to seek for an inde- 
pendent explanation for each of the two shares. 
Thus the theory of specific productivity declares 
that capital and labor receive each its specific 
product. 

Another method rests on a denial of the 
possibility of an independent explanation for 



INTRODUCTION 19 

either share and declares the existing division 
to be simply the outcome of a struggle between 
capital and labor. This is the view suggested 
by the frequent reference of German writers 
to Machtverhdltnisse, to relative power, as deter- 
mining distribution, and by the somewhat more 
definite ''bargain theory" of wages set forth by 
Davidson.* 

In seeking to account for the division of 
product between capital and labor, we appear 
to be restricted in our choice to one of the three 
methods just indicated. We must find (i) 
an independent explanation for either wages or 
the gains of capital, in which case we may 
account for the other share as residual. If that 
cannot be done we must either find (2) an inde- 
pendent explanation for wages and also such an 
explanation for interest, or (3) we must regard 
the division of product between capital and 
labor as the outcome of a tug of war. 

* The Bargain Theory of Wages. 



CHAPTER II 
bohm-bawerk's theory of interest 

It is a not uncommon practice to treat of 
one of the shares in distribution, of wages, for 
instance, or interest, or rent, without showing 
its relation to the remaining shares. A satis- 
factory theory of any one, however, impHes 
some particular view in regard to the others. 
Every consistent thinker on these subjects 
holds a definite theory of distribution as a 
whole. He cannot rest satisfied with discon- 
nected theories of wages, interest, profit, and 
rent. But, however desirable it might appear 
to consider theories of the entire process of 
distribution, rather than theories of particular 
incomes, a critical study such as has been 
proposed above, must accomodate itself to 
the disjointed character of economic discussion. 
A beginning must be made with some one of 
the so-called shares, and for various reasons . 
the theory of interest will best serve as an 
introduction to the problem before us. 

Now a strategic point at which to begin 
is given by the agio theory of Bohm-Bawerk. 
It is a highly developed and individual doctrine, 
based on a searching criticism of other theories. 
Stated with great clearness and amply elabor- 
ated, it is free from the obscurities of much 
of the older speculation on this subject. It 



BOHM-BAWEUK'S THEORY OF INTEREST 21 

will be desirable, therefore, in the case of this 
eminent writer to depart from the rule, adopted 
in most of the following pages, of considering 
general types and schools of thought rather 
than the formulations of particular theorists. 

The fundamental concept of Bohm-Bawerk's 
theory is a preference for present goods over an 
equal quantity of future goods of the same kind. 
Because of this preference, he holds, interest 
is paid as a premium for present goods given 
in exchange for future goods; or expressed 
differently, interest is a discount to which 
future goods are subject when exchanged for 
present. Now undoubtedly a preference of 
this kind exists, and may manifest itself when 
there is occasion for comparing present and 
future simis of money, or commodities readily 
exchanged for money. This preference, however, 
obviously is due, in large part, if not wholly, 
to the possibility of obtaining interest from the 
investment of money. It is a result of the 
existence of the institution of interest rather 
than a possible factor in bringing about its 
existence. The problem raised by Bohm- 
Bawerk's theory therefore becomes the highly 
hypothetical one of whether, if there were no 
interest payment to be expected — if, for 
instance, interest were prohibited and the pro- 
hibition enforced, — there would still be a 
preference for present goods, (or money as a 
means of purchasing goods) over future goods 
(or money). And Bohm-Bawerk adds to the 



22 PROFIT AND WAGES 

hypothetical character of the problem by elimi- 
nating the effect of any uncertainty in regard 
to future goods, such uncertainty not being 
necessary to a preference for present goods 
though adding to the discount of future goods.* 
If a preference for present over future possession, 
existing independently of the possibility of 
obtaining interest and not arising from any 
uncertainty or risk attaching to the future 
goods, could be proved, this preference being 
felt by a considerable number of persons and 
to a degree sufficient to be of significance and 
to lend probability to a theory based upon it, 
then Bohm-Bawerk's theory would not, indeed, 
be fully established, but would have a clear 
title to further consideration. For a complete 
demonstration of the truth of the theory, it 
would be necessary to show that such a prefer- 
ence for present goods could and does alone 
account both for the existence of interest and 
its amount.* 

As proof of the existence and operation of 
the preference for present goods to which he 
attributes the appearance of interest on capital, 
Bohm-Bawerk gives three "causes" of such 

*"I repeat that the element of uncertainty, which is the cause 
of a lesser value being put upon particular classes of future 
goods, has no causal connection with the phenomenon of 
interest. The lesser valuation which is its effect is a special 
one, and extends to one class of future goods only, and there 
it bears the character of a deduction as premium for risk." 
Positive Theory of Capital, p. 247. 

* *Except in so far as the amount is affected by the element of risk. 



BOHM-BAWERK'S THEORY OF INTEREST 23 

preference: (i) differences in relative pro- 
vision for present and future wants, typical 
cases being that of immediate distress and that 
of prospects of increased wealth in the future, 

(2) the underestimate of future advantages 
and future goods due to want of imagination, 
defect in will, and the uncertainty of life, and 

(3) the "technical superiority" of present goods. 
The third of these causes of preference, being 

based on a technical fact in the field of pro- 
duction, is evidently of a different nature from 
the other two. It is also the one which has 
been most called into question, and, therefore, 
may properly be the first to be subjected to 
a critical examination. The "technical superi- 
ority of present goods," according to Bohm- 
Bawerk, rests on the greater productivity of a 
long process of production compared with any 
shorter process using the same quantum of 
productive powers. In this statement the 
process of production of any commodity must 
be understood as including not only every step 
in making and marketing the commodity in 
question, but all preliminary steps, such as 
extracting and refining the raw material, making 
and transporting necessary instruments of pro- 
duction, et cetera. The longer process, therefore, 
is the one with the relatively larger amount of 
the results of previous labor employed in the 
later stages. In the older and more familiar 
phrase, it is the one with the larger "investment 



24 PROFIT AND WAGES 

of capital."* The proposition that an extension 
of the process of production over a longer 
period results in an increase of product per 
unit of investment, is at bottom only the 
familiar assertion of the productive advantage 
of increasing capital equipment. Bohm- 
Bawerk's novel formulation of this, however, 
led to some controversy. In his Strittige Fragen 
and in the third edition of the Positive Theorie 
des Kapitales, he has no difficulty in disposing 
of most of the objections made to the proposi- 
tion in question. However, it appears that a 
continued lengthening of the production period, 
beyond a certain point, results, not in an increas- 
ing, but in a decreasing rate of return.** With 

*The amount of capital invested does not, however, vary- 
exactly with the length of the productive process. See third 
edition of the Positive Theorie des Kapitales (Exkurs V). 

**To measure the length of the production period of any com- 
modity, we must take, according to Bohm-Bawerk {Positive 
Theory, page 88), not the "absolute" duration, the time elapsing 
between the first step in the process and the last, but its average. 
The latter is calculated by first multiplying each productive 
unit invested (of labor and of "uses of land") by the number 
of years from the time of investment to the completion of the 
consumable commodity, then adding together these arith- 
metical products and dividing by the number of units invested. 
Bohm-Bawerk, in his explanation, leaves out "for the sake of 
simplification," the co-operating "uses of land." In this we 
may follow him with a clear conscience if we reflect that, on 
the margin of land, there is no special outlay for rent and 
hence no investment, other than what is paid for labor, entering 
into the calculations of the entrepreneur. Now let us assume 
the total of labor employed in making a given commodity to 
remain unchanged, the length of the production period being 
increased by increasing the proportion of this labor invested 
in the earlier stages of the productive process. The result 
would be an increasing proportion of equipment to labor at 



BOHM-BAWERK'S THEORY OF INTEREST 25 

this qualification we may accept Bohm-Bawerk's 
proposition in regard to the relative productivity 
of different production periods. 

Now can it be shown that the greater produc- 
tivity of the longer processes is a reason for 
preferring present to future goods or earlier 
to later ones? The only way to do this would 
be to show that, of productive processes to be 
begun at different times, those with an earlier 
start are the longer and consequently more 
productive ones, or, in other words, that post- 
poning a process of production means shortening 
it and thereby diminishing its productivity. 
But a shortening of postponed enterprises at 
a sacrifice of productive efficiency would be 
without motive, unless it be permissible to 
assume that whether the start be early or late, 
the date when the product is completed is the 
same. It is as if we had to decide that whether 
we begin in 1914 or 1915 or 1916, the product 
was to be finished on, but neither before nor 

the later stages. The entire product would pass through the 
hands of the laborers at the latest stages and their output, 
therefore, would measure the productivity of the whole process. 
After the increase of the production period has brought about 
the maximum, amount of equipment each of these laborers 
could use effectively, and the maximum he could produce, 
further extensions of the process would result, at best, in no 
increase and, perhaps, in a decrease of the product per laborer. 
At the same time the number of these laborers is diminished 
as more of them are shifted to the earlier stages. The outcome 
would be a decline in the total product, and as the total of 
labor invested was assumed to remain unchanged, a corre- 
sponding decline in the amount of product per unit of labor 
invested. A further extension of the production period would 
be to no one's interest. 



26 PROFIT AND WAGES 

after, a definite date in 191 7. Obviously such 
an assumption respecting the time when pro- 
ductive processes must yield their fruit, is 
without warrant save as applied to exceptional 
cases. Contracts for completing buildings or 
furnishing supplies within a certain time (not 
usually on a definite date) are common enough, 
but being made under conditions which allow 
practically no choice as to the time of beginning 
work, are not relevant to our problem. The 
only occasions for comparing productive pro- 
cesses begun at different times, but aiming at 
completion on the same date, would be those 
created by expected events or opportunities 
of a temporary and unusual character, by what 
German writers would call a Konjunktur. Such 
would be the occurrence of an international 
exposition, the opening of a canal or of a new 
railway, the outbreak of a war, etc. But most 
economists would agree that there is a difference 
between a Konjunktur gewinn, the gains of a 
special and temporary opportunity, and interest 
on capital, and that the latter income must be 
derived from some more constant and regular 
source. As regards the great majority of 
productive operations there is no occasion for 
comparing the results of processes begun at 
different times and no necessity for shortening 
postponed processes because of any need for 
completing them on a given date. It is, there- 
fore, impossible to prove a purely technical or 
productive advantage in present over future 



BOHM-BAWERK'S THEORY OF INTEREST 27 

possession of the means of starting a productive 
enterprise. The only conceivable conditions 
under which such a "technical superiority of 
present goods" could arise are too exceptional 
and restricted to form the basis of a theory of 
interest. 

The greater productivity of the longer process, 
of the larger investment of capital, under 
certain conditions and within certain limits, is 
a fact and one of some significance to the theory 
of interest. Bohm-Bawerk presents it as the 
most important of those which must enter 
into the explanation of the income of the 
capitalist. In the writer's opinion he does not 
overestimate the relative importance of the 
technical factor. It is, in truth, the only one 
of those given by him that constitutes an 
essential element of a general theory of interest. 
But he has not given the right name to the fact 
which he is using. It is not a superiority of 
present goods, i. e., a technical advantage 
of present over future possession, but the 
productive advantage of having a certain capital 
over that of having less capital or none at all. 
It may, perhaps, form the basis for a kind of 
productivity theory, but it cannot be fitted 
into a pure agio theory. In short, it does not 
constitute a direct and immediate cause of 
preference for present over future goods. 

In a more remote way, however, it may be 
the cause of such preference. If we grant 
that the greater productivity of the longer 



28 PROFIT AND WAGES 

process is one of the factors causing the existence 
of interest, and that the possibiHty of deriving 
interest from money, or goods convertible into 
money, is a good reason for wishing to have 
said goods or money now rather than later, 
we must conclude that the superior productivity 
of long processes is indeed a ground of prefer- 
ence for present goods. But such preference is 
a result, and not as Bohm-Bawerk would have 
it, a cause of the existence of interest on capital. 
In regard to the "technical factor" we may 
conclude, therefore, that its contribution to 
the creation or maintenance of interest on 
capital cannot be of the same nature as that 
of Bohm-Bawerk' s other "causes of preference 
for present goods." Bohm-Bawerk' s bias in 
favor of unitary theory, or, as Landry calls it, 
his "fear of eclecticism," has apparently led 
him to make a desperate attempt to demonstrate 
the technical factor to be a direct cause of 
preference for present goods, parallel in its 
action with the other two factors. Such an 
attempt must necessarily fail and the three 
"causes" cannot be brought together under 
one head. If all three are to be retained for 
the explanation of interest, a theory resting 
on time-preference alone, a pure agio theory, 
is an impossibility. 



CHAPTER III 

THE TIME-PREFERENCE THEORY 

The conclusion reached in the preceding 
chapter that Bohm-Bawerk's technical factor 
will not fit into a pure agio theory, is that held 
by apparently the great majority of economists. 
With some qualifications, perhaps, this factor 
may form the basis of a kind of productivity 
theory. It cannot be made to appear as a 
direct cause of a preference for having goods 
at one point of time, rather than at another. 
But now arises the question as to whether a 
satisfactory theory may be reached by elimi- 
nating the technical factor from consideration 
and operating with the other two causes of 
preference, those which a careless but con- 
venient usage permits us to call the subjective 
factors. This has been the method of several 
recent writers* and may be regarded as a very 
consistent development of the tendency to 
reduce economics to a theory of valuation. It 
merits a careful examination. But instead of 
assuming the active existence of the subjective 
factors and inquiring merely into their sufficiency 
to give a complete theory, it is necessary to 
approach the problem in a more fundamentally 
sceptical attitude and to ask whether these 

*Especially Professors Fetter and Irving Fisher. 



30 PROFIT AND WAGES 

factors actually play any part whatever in 
bringing about the existence of interest or in 
regulating its amount and percentual rate. 

Let us then take a glance at the two non- 
technical or subjective causes of preference 
mentioned by Bohm-Bawerk. In regard to the 
second of these, the underestimate of future 
advantages, it may be admitted that lack of 
imagination, weakness of will in the face of the 
temptations of present enjoyment, the uncer- 
tainty of human life and, perhaps, other cir- 
cumstances, may bring about a tendency to 
over-rate present compared with future goods. 
This, of course, is acknowledging the existence 
of uneconomic tendencies. It is admitting the 
irrational, the uneconomic man as a disturbing 
force into the beautifully ordered, rational 
world of economic theory. Yet if actual man- 
kind is so irrationally disposed, why not recog- 
nize the fact in economic study? Doubts 
regarding the importance of the factor, arise, 
however, when we ask whether persons whose 
preference for present goods rests on such 
weakly human grounds are likely to be in a 
position to offer sufficient security for the 
fulfillment of contracts, to be enabled to enter 
into an exchange of future for present goods. 
The important question in this connection, in 
fact the only relevant question, is not whether 
such preference for present goods might or does 



THE TIME-PREFERENCE THEORY 31 

exist, but whether it plays a part in the business 
facts that give rise to interest on loans and 
investments. 

And the same remark applies to Bohm-Bawerk's 
first cause of preference for present possession. 
We may grant that an anticipated relatively 
more abundant provision for future wants is 
an experience entering into the lives of a con- 
siderable number of persons. That is, they 
have such anticipations, whether or not these 
lead to any conscious preference for present 
goods or to actual offers of a premium for 
present possession. That it is the experience 
of the majority may perhaps be doubted and 
it is not impossible that conditions may be 
reversed and the present be the relatively better 
provided for. In that case it would be rational 
to feel a preference for future over present goods. 
This possibility is hardly referred to by Bohm- 
Bawerk, whose thinking is directed toward 
finding the explanation of interest in what he 
considers the almost universal human attitude 
of a preference for goods in the present.* Of 
course those who prefer future goods to present 
goods, might be represented along with those 
having only a slight preference for present goods, 
as parties to an exchange with those feeling a 
relatively strong preference for goods in the 
present. But, on the whole, the agio theory 

*However, he holds that for most capitalists this preference 
rests on the "technical superiority" of present goods and that 
the first two grounds of preference, the subjective ones, are 
of no effect. See 3d ed. of Positive Theorie, p. 521. 



32 PROFIT AND WAGES 

requires that preference for present goods be a 
more urgent and wide spread factor than the 
preference for future goods. If such should 
not be the case, that is if those preferring present 
goods could always find persons with a prefer- 
ence for future goods, an exchange might be 
arranged, advantageous to both parties, in 
which no interest or discount need appear. Now 
does Bohm-Bawerk's first "cause," the factor 
of a difference between provision for present 
and for future wants, take a shape such as to 
create a very general preference for goods in 
the present? It appears, at least, doubtful. 
Those whose income is gained by their own 
labor, may in youth have before them the 
prospect of earning power increasing with age 
and experience; but such increase of income 
may be accompanied by the increased expenses 
of a growing family, and will be followed by a 
decline of earning power with advancing years. 
Those, on the other hand, whose income is 
derived from investments, may have reason 
for expecting a constant growth of income from 
their increasing accimiulation of savings. Their 
relative underestimate of future goods would 
however be due to the existence of income on 
capital. To represent it as a cause of interest 
would obviously be reasoning in a circle. 

Bohm-Bawerk's first two grounds of prefer- 
ence for present goods, the subjective factors, 
appear, therefore, to oifer no very secure founda- 
tion to a theory of interest. In fact, Bohm- 



THE TIME-PREFERENCE THEORY 33 

Bawerk himself virtually surrenders them except 
in his theory of the "consumption loan." The 
exponents of the pure agio theory, however, 
have put forward no other grounds of such 
preference. They rest their case entirely on 
something for which no adequate explanation 
has been given. 

But for the sake of argument let us grant 
that there may be good reasons for wishing to 
have goods at one time rather than at another, 
and that, on most occasions the preference 
would be for goods in the present. For any 
preference, one way or the other, between goods 
to be got at different points of time, we may 
use the convenient term time- preference."^ When 
such preferences are presented as growing out 
of fairly definite, quantitative comparisons, we 
evidently have an extension or development of 
the Austrian theory of value; the "economic 
man" being represented as comparing the rela- 
tive utilities not only of different goods in the 
present and immediate future, but of the 
prospective goods of years to come. Interest 
becomes a problem in "subjective value." For 
let us note, that w^hen Bohm-Bawerk's technical 
factor is eliminated from consideration, the 
comparison between goods, or between the 



*This term is used by Professor Irving Fisher but in a more 
restricted sense, as a preference for present over future goods. 
{The Rate of Interest, p. 88 and elsewhere.) In Professor 
Fetter's Economics the term time-value is used in the sense 
in which time-preference is employed here. 



34 PROFIT AND WAGES 

"incomes" from goods coming at different 
points of time, is made by the consvimer and 
between consumable goods only. 

This may arouse doubts in regard to the 
applicability of the theory to those facts in 
which the consensus of opinion among econo- 
mists looks for the chief source of interest. 
What part do the factors it emphasizes play 
in real business? When capital goods or profit- 
able opportunities are valued, it is on the 
basis of expected pecuniary returns, of that 
interest whose nature and amount the theory 
in question seeks to explain, of the objective 
facts of the industrial world rather than of the 
subjective states of the consumer. How to 
bridge the gulf between the subjective, the 
consumer's estimates of goods, and the objective 
facts of industry, constitutes a serious problem 
for those who would base interest on time- 
preference alone. 

What are the actual mental states of the 
men who put their capital into business and 
get an income in the shape of interest? The 
professorial imagination has displayed great 
ingenuity in showing how comparisons between 
present and future utilities might be made and 
time- values noted. But such mental exercises 
are of no importance unless time-preference is 
a psychic state that actually enters into the 
transactions out of which interest grows ; unless 
it plays a part in borrowing, lending, and 
investing. The only relevant question, there- 



THE TIME-PREFERENCE THEORY 35 

fore, is not that as to possible reasons for having 
a time-preference, or as to the possibiHty of 
the occurrence of this state of mind, but as to 
whether such a preference or valuation is an 
essential part of the psychology of business. 
What really goes on in the investor's mind? 
In the borrower's and in the lender's mind? 

That economists have been so ready to accept 
time-preference as a factor affecting invest- 
ment is possibly due to an uncritical identifica- 
tion of it with the older concept of abstinence; 
the transition from the older to the more recent 
conception being facilitated by the use of 
such terms as postponement, prospect iveness, 
and waiting. In the idea of an exchange of 
present against future goods in which time- 
preference may play a part, we have, however, 
something essentially different from the thought 
of the older abstinence theorists, and a view 
of things less likely to recommend itself to an 
unsophisticated understanding of what takes 
place in this world. By the older writers 
abstinence was taken to mean abstaining from 
consumption in order to accumulate and invest 
capital, and the continuance of the abstention 
in order to maintain the capital accumulated. 
It was regarded as involving some deprivation 
or "cost" and, therefore, requiring some com- 
pensation. Interest was the necessary "reward 
of abstinence." This view, however, did not 
of necessity imply that in the exercise of absti- 
nence there was a postponement of consumption, 



36 PROFIT AND WAGES 

i. e., that the capital sum saved and maintained 
by abstinence, was ever to be consumed. Such 
an idea, however, is suggested by Bohm-Bawerk's 
exchange of present for future goods. It imphes 
in the capitahst's mind a comparison of two 
quantities of consumable goods; of a present 
quantity on the one hand, with an equal future 
quantity of goods, in addition to the interest, 
on the other. 

This manner of presenting the calculations 
of investors is an obvious departure from the 
facts, a misrepresentation of the psychology of 
investment. Very few investors ever con- 
template consuming what they call their capital. 
Investment to them does not mean postponing 
the consumption of the equivalent of what they 
have saved. In fact, whatever hardship or 
cost may have been involved in saving a given 
capital, it would probably appear a more 
heartrending thing to be obliged to consume the 
capital that has been saved. The capital sum, 
therefore, does not enter into both terms of 
the comparison between present and future 
goods. What the investor does is to compare 
the present or early consumption of, let us say, 
one thousand dollars worth of goods once and 
for all, with the later consumption of a per- 
manent, annual income of fifty dollars worth 
of goods, obtainable without labor. There is 
a comparison, indeed, of consumable goods, 
or if you will, of ''psychic income" or utilities 
of goods ; but it is of goods or income appearing 



THE TIME-PREFERENCE THEORY 37 

under very different conditions. The one thou- 
sand dollars if spent for purposes of consumption 
are gone. Another accumulation of one thousand 
dollars can be obtained perhaps only by per- 
forming labor. The fifty dollars received as 
interest, may be spent, but an equivalent sum 
will come again, year after year, and without 
exacting labor from the investor. A relatively 
large temporary satisfaction of wants may be 
given up when one thousand dollars is saved; 
a permanent, unlaborious recurrence of a much 
smaller sum is gained. The permanent char- 
acter of interest income and the fact that it 
comes without labor on the part of the recipient, 
are to the capitalist the significant character- 
istics of the "future goods" he purchases by 
means of his "present goods." These real or 
apparent characteristics a theory of interest 
must account for. Their existence granted, 
we can see why men will make sacrifices to 
obtain interest. 

In the case of the active entrepreneur, as 
distinguished from the capitalist -lender, the 
calculations of an investment are slightly differ- 
ent, but equally unfavorable to the time- 
preference concept. The entrepreneur also hopes 
to get a permanent income as a percentual 
rate of his thousand dollars; but he looks for 
a higher rate than the capitalist, for what 
following the usage of the classical economists, 
we may call "profits of capital." When receiving 
the higher rate he does not expect entirely to 



38 PROFIT AND WAGES 

avoid risk and labor. The most important 
aspect of investment to him is the fact that it 
represents business opportunity. Neither cap- 
italist, nor entrepreneur, however, let a future 
capital sum enter into comparison with present 
goods. They are not conscious of making any 
such exchange of present against future goods 
as is suggested by the language of Bohm- 
Bawerk and his followers. 

It is evident that the purposes and calcula- 
tions that lead up to and prevail in the process 
of investment are not those suggested by the 
theory under consideration. Time-preference 
is certainly not consciously present and it is 
hard to see how the institution of interest can 
rest upon a mental state which capitalists would 
fail to recognize as having any connection with 
their business. Indirect evidence, moreover, 
that estimates of time value are not an important 
factor may be found by considering the rates 
of interest on loans for different lengths of 
time. If a comparison of the utility or value 
of the capital sums loaned and returned, or 
of the goods these sums represent, played any 
part, then the longer the time intervening 
before the payment of the loan, the higher the 
agio or total of interest necessary as premium 
on present goods or discount of the distant 
future goods. If the preference for present 
possession grew in direct ratio with the length 
of the loan period, a uniform annual rate of 
interest would be demanded for all loans of 



THE TIME-PREFERENCE THEORY 39 

equal risk. A thirty year loan of one thousand 
dollars, for instance, would receive six times as 
many annual payments of fifty dollars as a 
five year loan. But perhaps it may be argued 
that if time preference governs the loan market, 
a prospect of payment at a very distant date 
would call for a higher rate of discount than a 
short period loan, that if a five year loan is 
satisfied with 5 x $50, a thirty year loan would 
demand 30 x $60 ; preference for present goods 
and sums growing at a greater rate Jian the 
time interval before the final payment. The 
facts of the loan market, however, do not fit 
either of the above suppositions as to the rate 
of growth of preference for present possession 
with increasing remoteness of future payments, 
and do not, therefore, fit the necessities of the 
time-preference theory. Instead of a rate of 
interest on long time loans equal to or greater 
than that on short loans, we usually have a 
lower rate ; evidence that an undisturbed annual 
income is desired and not the return of the 
whole equivalent of the "present goods" invested. 
Something needs to be said about the idea 
of an exchange of present against future goods 
which has played more or less of a part in the 
agio theory. The term "exchange" suggests 
two parties. "It takes two to make a trade." 
The investor or capitalist gives present goods in 
return for future goods. But who is it that 
gives the future goods? In the so-called "con- 
sumption loan" the borrower appears clearly 



40 PROFIT AND WAGES 

to be the one who offers things in the future. 
But the consumption loan is one of the minor 
incidents of the modern economic system and 
may be passed over for the present. If it is 
not possible to make the idea of a trade in 
time-values fit the facts of the "production 
loan" and the use of capital in business, the 
major characteristics of the capitalistic world, 
it is evident that the factors suggested by it 
can play at most a very subordinate part. 

Turning, therefore, to the production loan, 
we ask, who are the parties to an exchange in 
which present goods are given for future goods? 
Is there such an exchange between the capitalist 
as lender and the entrepreneur as borrower? 
The capitalist gives up present goods to the 
entrepreneur. The latter, however, far from 
consuming them, turns them into his business 
and looks for a future return. Obviously both 
entrepreneur and capitalist look for a future 
return. They share in the profits of capital. 
The capitalist because free from risk and the 
labor of directing the productive and com- 
mercial process contents himself with a part 
of these profits known as interest. Interest is 
"commuted profits."* What is really given 
in exchange, therefore, is not consumable quan- 
tities of wealth of different date — like the 
dinners of polite society — but different means 
and conditions of securing income. The entre- 
preneur receives the means of controlling the 

*Hadley, Economics, p. 270. 



THE TIME-PREFERENCE THEORY 41 

productive or business process, the opportunity 
of making a gain by luck and the exercise of 
his business talents. The capitalist, on the 
other hand, receives an income without labor 
and often substantially without risk. But 
both devote present wealth to future income. 
If anywhere, there is an exchange of present 
against future goods, it is not between entre- 
preneur and capitalist. We must look else- 
where for an answer to the question as to who 
gives the future goods. 

If there is an actual exchange of earlier for 
later goods, connected in any way with the 
capitalistic production of wealth, apparently 
it must be between entrepreneur and laborer, 
the laborer being the seller of future goods. 
Now the wage contract may indeed be regarded 
as an exchange, but not as a conscious exchange 
of time- values. The laborer knows nothing 
of giving future goods. He has no goods to 
give, either now or in prospect. As Loria 
remarks, he is not so fortunate as to compete 
with the Roman Church in its traffic in future 
blessings.* He has only his labor-power. That 
may be used to produce goods which are to be 
finished and sold in the future, and so, by figure 
of speech, these products, and the labor-power 
itself, may be called "future goods." But this 
labor-power is a future good that can seldom 
"ripen" into a present good unless the employer 
consents to take it into his hire. So all that will 

*// capitalismo e la scienza. Chap. I. 



42 PROFIT AND WAGES 

be clear to the employe's mind is that with the 
employer's consent, he may work and receive 
wages. The goods he makes, he cannot think of 
giving in return for anything, because they 
are not his to give. All the characteristic features 
of an exchange are lacking. Yet if interest is 
to be accounted for as the agio in an exchange 
of time- values, the employe must be represented 
as giving commodities which he may never 
see in their completed form, whose amount and 
value he does not know, and — giving them 
subject to a discount. That discount, if there 
is a conscious trade in time- values, should 
satisfy the time-preference of both employer 
and laborer. But it requires no argument to 
show that the laborer knows nothing about such 
a discount. If he has not read the latest theorist 
he does not suspect that he has a rate of time- 
preference at all. Was any such rate ever men- 
tioned in the contest between trade-union and 
employer? 

Possibly the obvious absurdities of the idea 
of an exchange when applied to the wage- 
contract, — the one business relation in which 
present goods appear to be given for future goods 
on a large scale — are not necessary implica- 
tions of the time-preference theory. Perhaps 
the use of the term "exchange" is simply an 
instance of unhappy terminology and may be 
avoided.* It might be argued that although 

*It may be suspected that if it were not for the apparent apolo- 
getic value of the idea of an exchange between present and 
future goods, the idea would have received little notice. 



THE TIME-PREFERENCE THEORY 43 

the laborer is no conscious buyer or seller of 
time- values, the time-preference rate of cap- 
italist and employer determines the rate of 
profit and interest. In that case, in trying to 
demonstrate a general preference for present 
over future enjoyment, the time-preference 
theorist may eliminate the laboring classes from 
consideration as irrelevant to the subject.* 

To state the possibly consistent time-prefer- 
ence theory which may be reached by dis- 
carding the idea of a conscious bargain in time- 
values between employer and employe, — the 
laborer might be represented as merely selling 
his labor for what he can get, while employers 
are led by competition to pay the discounted 
value of the product of that labor, the rate of 
discount being determined by the capitalist's 
rate of time-preference. This, of course, is 
possible only on the assumption that capitalists 
prefer present to future goods and at a definite 
rate of preference (at least, so far as the marginal 
supply of capital is concerned). That the com- 
petition of employers will give the laborer the 
full product of his labor discounted at not 
more than the "necessary" rate of discount, 
is of course one of the cheerful assumptions of 

*The time-preference of laborers is of significance, in this con- 
nection, only in so far as laborers are capitalists and not always 
even then. A large part of the savings of the working class 
are such savings "for a rainy day" as would be made even if 
there were no interest receivable upon their accumulations. 
We may infer, therefore, that but a very small part of the 
capital funds of the world are affected in any way by the 
preference of laborers for present over future goods. 



44 PROFIT AND WAGES 

the productivity theory of wages. This assump- 
tion, as will be shown in a later chapter, is 
questionable. Let us note only, that if one is 
willing to accept the productivity theory of 
wages in the form just stated, and also the 
idea of a definite rate of time-preference held 
by capitalists, we can get a very consistent 
theory of the rate and amount of interest and 
profit of capital. Capitalists and entrepreneurs 
as a class pay simply wages, nothing more.* 
These wages according to the theory just 
suggested are the discounted value of the total 
product, the discount being determined by the 
time-preference rate of the capitalist class. 

This theory would not give us a complete 
theory of why there is interest at all. A complete 
explanation of the existence of the institution 
of interest and profit of capital would have 
to take definite cognizance among other things 
of the existence and conditions of a special 
class so situated that its rate of time-preference, 
if indeed it has one, can play no part in deter- 
mining the share that it may get of the product 
of its labor. But the formulation of a complete 
theory of the existence of interest is a difficult 
and probably impossible task. In our view the 
method of theory should attack primarily the 
problem of the rate and amount of each share 
in distribution. As a theory of the rate and 
amount of the income of capital, the time- 

*Setting aside rent and taxes and, of course, all payments not 
connected with the productive process. 



THE TIME-PREFERENCE THEORY 45 

preference theory, as we may have seen, may be 
stated in fairly consistent form. It rests on 
certain dubious assumptions in regard to the 
wage-contract which will be reserved for later 
examination. The objection against the theory 
to be stated at this point, however, is the one 
suggested by our analysis of the psychology of 
investment. There is no comparison between 
present and future capital sums and no dis- 
coverable definite subjective rate of time-prefer- 
ence in the minds of capitalists and entrepreneur. 
Whatever be the mental states of these gentle- 
men, they are not those suggested by this 
theory. Whether some other, happier formu- 
lation of the subjective condition of the capitalist 
class can be substituted for the time-preference 
notion, and give us a satisfactory theory of 
the rate and amount of capitalist gain, may be 
left to later consideration. At this point we 
are concerned only to show the failure of the 
time-preference theory. 

Other than the contract between entrepreneur 
and laborer, the only transactions that suggest 
the idea of an "exchange" of present for future 
goods are the loan for consumption and the 
purchase of durable goods. To imagine the 
parties to a consumption loan as adepts in the 
utilitarian calculus, with definite time-prefer- 
ences, may be less difficult than most of the 
trials of faith imposed upon us by the time- 
preference theorists. However, it seems some- 
what doubtful whether actual cases of such 



46 PROFIT AND WAGES 

mental attitudes are discoverable. In any case 
it does not appear probable that subjective 
factors alone could account for the rate of 
interest on this class of loans. The lender, for 
instance, is less likely to think of his present 
and future "psychic incomes," than of the risk 
and of the rate of pecuniary return on the various 
investments, productive and unproductive, open 
to him. Is it not simpler to regard the interest 
payment on a loan for consumption as a deriva- 
tive phenomenon and look for a fundamental 
theory of interest in the circumstances determin- 
ing the income on productive loans and invest- 
ments? After all, a secondary phenomenon such 
as the consumption loan affords too narrow a 
basis to support a comprehensive theory of 
capitalistic income. 

When we come to consider durable goods, 
we are asked by the time-preference theorists 
to regard the purchaser as buying the future 
utilities or services given by these goods and, 
therefore, estimating the value of the goods 
he buys by discounting these psychic futurities. 
The most durable of all purchasable things is 
land. According to this theory, the price paid 
for a piece of land, or, in other words, the 
present goods given in exchange for the future 
goods to be derived as income from the land, 
must equal these future goods discounted accord- 
ing to the prevailing rate of time-preference. 
The price, in short, is the present value of a 



THE TIME-PREFERENCE THEORY 47 

seemingly endless series of annual incomes.* 
Calculation of the price would have to proceed 
by adding the discounted values of the successive 
prospective annual returns until returns so 
remote were reached that their present value 
is infinitesimal. Obviously this is not and 
never was the method followed by any actual 
buyer of land. 

With some goods of a less durable nature 
than land, as, for instance, in the case of a 
dwelling house, the calculation supposed by 
the time-preference theory, may seem less 
absurd. But how is it with goods of a still less 
durable character, a piece of cheap furniture, 
for instance, or a suit of clothes, or a box of 
cigars? Their utilities are spread out over 
future time. Do we discount these utilities 
when we think of buying the articles? All, 
even the most evanescent goods, are to be 
consumed at a future moment, though that 
future be but a fraction of a second removed 
from the present. Must we be prepared to 
view the discounting of "psychic income" as 
entering into the determination of all commodity 
values? Here obviously we are beginning to 
approach the absurd. 

Now possibly the application of its funda- 
mental principle to the value of consimiption 
goods is not necessary to the time-preference 
theory. It has been referred to here to show 
how far the bias in favor of psychological 

*B6hm-Bawerk does not hesitate to call it an "infinite" series. 



48 PROFIT AND WAGES 

theory has led the exponents of time-preference 
away from reahty. If economics must get 
back to subjective factors, why not consider 
income as consisting of utiHties rather than of 
the goods giving these utihties? And if utiUties 
are income, why should not the income be 
capitalized? In other words, why not arrive 
at the value of a cigar by discounting the 
prospective pleasures of a smoke? "Logic 
is logic" even when it leads to absurdity. But 
obviously the unblenching subjective valuation- 
ists have led economic theory far from the 
observable facts of industrial life. 

The departure from reality has come, of 
course, by stages. As Private Mulvaney would 
say, "one thing led to another." First, we were 
given the "economic man" — not a real man 
but supposed to be enough like a man of business, 
during business hours, to illustrate what might 
happen in the industrial world. Then this 
"economic man" developed into a Benthamite 
psychologist, but ever growing more subtle 
in his thinking, weighing and comparing utilities 
— after a time even of infinitesimal increments. 
Differential calculus was called upon to demon- 
strate the precision of his thought. When 
after a time the feeling of strangeness had 
worn off and our economist Frankensteins 
began to feel at ease with their monstrous 
creation, they saw that the clever creature 
could not be confined to estimating utilities 
that are all within one area or zone of time, 



THE TIME-PREFERENCE THEORY 49 

as if he had no sense of time at all. No, he must 
look ahead and project his arrangement of 
utilites far into the future. So carefully does 
he distribute his consumption of commodities 
over the days, months, and years, that the 
least want satisfied at any moment of time 
has the same importance as the marginal want 
satisfied at any other moment. If by some 
investment of wealth, he disturbs his beautiful 
Squilibre de la consommatio7i, he knows exactly 
what rate of interest he must demand to com- 
pensate for the cost of this disturbance.* Such 
are the achievements of this hero of economic 
mythology. He has delighted our fancy, but 
the time has come to ask whether anybody 
ever saw anything like him in sober reality. 
And it is reality which economists profess to 
describe, though of necessity employing the 
method of abstraction. By "successive approxi- 
mations," we have been led to hope, the abstrac- 
tions of economic theory could gradually close 
in upon reality, almost attaining it. But 
obviously there are economic speculations that 
act more like successive dispersions from the 
facts of life. 

Of course, we may expect that soon or late 
there will appear a sceptical reaction against 
the development of the principle of subjective 
valuation, and a disposition to appeal to the 
coarse judgments of the popular consciousness. 
Thus Lexis writes in opposition to the agio 

*Landry, Vinteret du capital, Chap. II. 



50 PROFIT AND WAGES 

theory — though apparently thinking only of 
Bohm-Bawerk's exposition and not of the fine- 
spun developments of recent writers — that 
"the question of the significance of a time- 
difference — the distantia temporis — between 
the beginning and end of a loan-transaction 
* * * was considered by the Canonists. The 
profit on a bill of exchange was justified by the 
difference in monetary standards and the dis- 
tance between the place where the bill was 
drawn and the place of payment. But for the 
time difference all compensation was uncon- 
ditionally excluded — evidence that the idea 
of a difference in value between a present and 
a future sum was as remote from the economic 
consciousness of that time as it is from the 
minds of the money lenders and house owners 
of today. But motives and considerations 
which do not demonstrably and consciously 
determine the actions of individuals and thereby 
cause collective phenomena {Massenwirkungen) 
cannot be regarded as factors of any importance 
in political economy {wesentliche Faktoren fur 
die Volkswirtschaft) . " * 

Possibly Lexis carries his scepticism too far. 
The refusal to consider anything but factors 
which are demonstrable and conscious to the 
popular mind, might exclude actually operating 
forces from examination. The popular mind 
is not acute in analysis nor conscious of its own 
processes. If, for instance, the question whether 

^Article Zins in Worterbuch der Volkswirtschaft, Bd. II. 



THE TIME-PREFERENCE THEORY 51 

estimates of marginal utility entered into the 
ordinary shopper's mind were submitted to 
any group of plain people, the answer probably 
would be an hilarious negative. Yet while 
the average man would find it difficult to 
discover by introspection any of the subtle 
workings of the utilitarian calculus, relative 
marginal utility may after all have some influ- 
ence on the distribution of his expenditures. 
Not that he carefully compares utilities. But 
if the marginal utilities of different lines of 
expenditure get out of alignment, a distressing 
insufficiency at some point will lead to sober 
reflections and an effort to make a better pro- 
portioned provision for the different groups of 
wants. Moreover, imitation leads to a dis- 
tribution of expenditures according to class 
standards, the outgrowth of the experience of 
the class and its gradual but not clearly conscious 
adjustment of expenditure to money income. 
The marginal utilities that affect the relative 
demand for different commodities on the market 
are to a large degree objective facts and social 
standards to which the individual conforms 
unconsciously. 

Thus marginal utility although not recog- 
nized by the popular mind, is a factor to which 
economic theorists are justified in giving some 
recognition. But when we come to deal with 
time- values and preferences, we are entering a 
sphere where even the roughest, least conscious 



52 PROFIT AND WAGES 

adjustment of expenditure to relative needs 
seems to be beyond the reach of probabiHty. 
Manipulation of the ''time-shapes" of income 
is practically impossible. To be sure, some 
successful spreading of expenditure, of the 
"psychic income" of the consumer, over the 
week, the month, even over the year is accom- 
plished. It has been the study of many a 
pedagogical household. But who would claim 
that this has any perceptible effect on the 
business of deriving interest from capital invest- 
ments? For longer periods of time, the unfore- 
seeable changes in subjective and objective 
conditions of life, make both the experience 
of the individual and of social classes of no 
avail in effecting any rational equalization 
over time, of the stream of "psychic income." 
We have a right to demand that in theorizing, 
more definite and demonstrable factors be taken 
than the "time-shape" of income, "time- values," 
and "rate of time-preference." To reach general 
conclusions economists are obliged to assume the 
action of intelligent self interest, to picture life 
as more rational than it is in reality. The time- 
preference theory, however, carries rationalism 
to excess. By attributing superhuman powers 
to the economic man it becomes completely 
detached from the actual world. A highly 
hypothetical proposition, subjected to succes- 
sive qualifications, may constitute the nucleus 
of a series of valuable "approximations" to 
reality. If, however, the first, obvious quali- 



THE TIME-PREFERENCE THEORY 53 

fication is a complete denial of the initial 
hypothesis, there should be an end of experiment 
with such fictitious stuff. The time-preference 
theory is a remarkably consistent piece of 
theorizing and therein doubtless lies its great 
attraction. But it is spun out of nothing. 

It is not denied that expectations, or let us 
say rather hopes and fears, of an increase or 
decrease in the proportion of income to wants 
may have some influence on saving, lending, 
and borrowing; may be among the psychic 
conditions out of which these acts sometimes 
arise. The business of life insurance depends 
on an appeal to such motives.* The amount 
of savings which seek interest -yielding invest- 
ments may be affected by their intensity. 
Influencing the supply of loan funds they may 
have some influence on the rate of interest. But 
to grant that these expectations, hopes, and 
fears have an influence on the rate of interest is 
far from admitting that they are a direct 
determinant, sufficiently definite and powerful, 
to be given a place in a carefully formulated 
general theory of the rate of interest. And 
in any case they are subordinate in importance 
to most of the purposes and calculations that 
rule in the direct investment of capital in the 

*It should be noted, however, that in buying Hfe insurance, 
the one really clear and important case of an occasion for 
comparing amounts of consumable wealth of different periods 
with reference to a diflEerence in the state of provision for the 
wants of these periods, the preference is for future goods, and, 
therefore, the reverse of the time-preference called for by the 
theory under consideration. 



54 PROFIT AND WAGES 

productive process. Of these calculations, we 
have seen, the concept of time-preference gives 
a false notion. We may conclude, therefore, 
that the effort to reconstruct Bohm-Bawerk's 
theory by eliminating the technical factor and 
basing the argument exclusively on subjective 
estimates of time-value, cannot contribute much 
to the elucidation of the problem of interest. 
The idea of a sacrifice of present goods in return 
for future goods may have some value in the 
apologetics of the capitalistic system. That, 
however, is of no concern to disinterested 
economic theory. The important fact is that 
time-preference has too little relation to the 
actual forces at work in the industrial world, 
to serve as an explanation of the amount and 
rate of capitalist income. 



CHAPTER IV 

THE ABSTINENCE THEORY 

The controversial success of the Austrian 
theory of value has created a bias in favor of 
explanations of economic phenomena in terms 
of subjective valuation. It has fostered the 
ideal of a unitary theory based on some psycho- 
logical factor. In the time-preference theory 
of interest we have the extreme expression of 
this tendency. It is, however, the only modern 
psychological theory of distribution which pro- 
fesses to offer all the elements of a theory. If 
we reject it, we must turn to objective, non- 
psychological factors for at least part of the 
explanation of the problem. The only other 
theory which may be called subjective or 
psychological is the abstinence theory. Recent 
adherents of the latter, however, do not claim 
completeness for it. It is advanced as a treat- 
ment of the factor of supply of capital only, as 
part of a dual theory of interest in which demand 
for capital is described as starting from technical 
and business facts. All that we need to con- 
sider, therefore, in reference to this theory is 
whether it states a factor affecting supply of 
capital sufficiently important to warrant its 
inclusion in a general theory and whether it 
correctly represents the mechanism by which 
this factor comes into play. 



56 PROFIT AND WAGES 

In favor of the abstinence theory it may be 
said that it gives a possibly less definite, but 
also less questionable, description of the mental 
states of the investor than the time-preference 
theory. In some modem versions the concept 
of abstinence is practically converted into that 
of time-preference. It is possible, however, to 
formulate the abstinence theory in such a way 
as to avoid the erroneous conception of an 
exchange of present against future goods in 
the form of an exchange of a present capital 
sum C, against a lump sum C-f-i (i representing 
interest). The exchange may be taken to be 
that of C against a series i, i, i, i, - - - 
of regularly recurrent sums. Abstinence is 
represented as the subjective cost of a per- 
manent, regularly recurrent (usually annual) 
income, obtained without labor. 

Now does this theory give us an entirely 
acceptable account of the psychology of saving 
and investment, of supply of capital? The 
answer will depend in part upon whether saving 
and investment really involve a subjective cost. 
If the term abstinence were taken to mean 
merely any abstention from consumption in 
favor of investment, it is obvious that it would 
frequently involve no perceptible subjective 
cost. But even when used in this broad, color- 
less sense, the term would be too narrow to 
apply to the mental states involved in all cases 
of investment. In many instances sums are 
invested that would not have been spent for 



THE ABSTINENCE THEORY 57 

consumption goods even if there had been no 
possibihty of investing them. In such cases 
there is, of course, no abstention or abstinence 
from consumption. The abstinence theory does 
not, therefore, at least in its cruder form, 
convey an entirely truthful impression of the 
psychology of the capitalist. Its implication 
of a subjective cost is true of only a limited 
part of the field of investment. Saving and 
investment without perceptible subjective cost 
or hardship occurs not only when there is an 
unspent residutun of an income so large that 
it would be distressing to the recipient to find 
ways of spending it. The maintenance of a 
capital sum once saved and its increase by 
accumulation at compound interest probably 
means little subjective cost to the confirmed 
saver even if he be the recipient of only a moder- 
ate income. Besides the saving of individuals 
there is growing up an increasingly important 
saving of an impersonal character. By depre- 
ciation accounts, the managers of corpora- 
tions provide for the maintenance of capital 
and by the accimiulation of surplus for an 
increase of capital, without the slightest con- 
sciousness of abstinence on the part of the 
majority of stockholders. And there is the 
"manufacture of credit" by banks. Whether 
this, however, constitutes an increase of capital 
in a real sense is a disputed point. 

It must be recognized, however, that modem 
expositions of the theory do not attribute all 



58 PROFIT AND WAGES 

saving and investment to abstinence. They 
aim primarily at an analysis of the factors 
determining the rate of interest. As they view 
the matter, it is the subjective cost or abstinence 
of the marginal savings that is just paid for by 
the rate of interest, the rate established by the 
equalization of demand and supply. Savings 
other than the marginal may be subject to little 
or no cost, but receive the benefit of the rate 
that must be paid in order to overcome the 
marginal saver's reluctance to undergo the 
necessary abstinence. The greater the amount 
of capital available throughout the field of 
industry, the less is gained by its use at the 
margin and the lower in consequence the rate 
of interest. If the rate rises as a result of 
greater demand, increased saving will be induced ; 
if the rate falls, the marginal savings will fall 
off because of diminished inducements. It is 
implied, therefore, by the theory, that saving 
rises and falls with the rate of interest though 
not necessarily in the same degree. Thus it 
regulates the supply of capital and thereby its 
marginal gains, in such a way as to establish 
a rate of interest that pays for the abstinence 
of the marginal savings. And it is further 
implied that the changes in the supply of saving 
necessary to bring about this equilibriimi 
between rate and abstinence, are in the saving 
which can be called marginal and involves the 
cost of abstinence. 



THE ABSTINENCE THEORY 59 

The interacting factors supposed to deter- 
mine the rate of interest are stated in terms of 
demand and supply. This gives occasion for 
some criticism of a more or less formal character. 
What is the meaning of "supply" of capital? 
Is it the supply of loan-capital only or of the 
total of capital whether borrowed or owned 
by those who employ it? Since the demand is 
represented as being regulated by the marginal 
"productivity" of capital, and this depends on 
the total of capital used, it is necessary to take 
the word supply as signifying the total. Now 
what rate have we to consider in this discussion, 
that of profit or that of interest? As the total of 
capital is under consideration, it is evidently 
the rate of profit. Yet the theory professes to 
be a theory of interest.* 

If the rate of profit and that of interest always 
varied together and in the same direction, it 
would not be misleading to represent the rate 
of interest by that of profit in a discussion of 
the interaction of demand and supply. There 
are theoretical grounds for expecting these 
two rates to move together. There appear to 
be, however, historical instances of their failure 
to do so and even of their going in opposite 
directions. Now as saving and the supply of 

*Sometimes the return on marginal investments of capital 
is represented as being interest only, the entrepreneur in 
search of profit having borrowed capital until all excess of 
profit over interest has disappeared on the last portion borrowed. 
Here the habit of thinking of infinitesimal increments has 
led to the improbable conclusion that entrepreneurs will do 
and continue to do things which result in no gain to themselves. 



6o PROFIT AND WAGES 

capital are represented by the theory under 
discussion as being in response to, or induced 
by, a rate of return, there arises the difficulty 
that some savers are affected by the rate of 
interest alone, others by the rate of profit as 
well as by the rate of interest. Those who are 
capitalists only, unwilling to run risks, without 
ability or inclination to manage a business, 
will not in their saving be affected by the rate 
of profit at all, unless that rate in its movement 
drags the rate of interest with it. The entre- 
preneur, however, in his saving will be affected 
by both rates, though conceivably in conflicting 
ways. If the rate of profit declines, he has 
apparently less inducement to save capital than 
before. If at the same time, however, the rate 
of interest should remain unchanged or should 
rise, he might have a stronger motive than 
before for owning the capital he uses instead of 
borrowing. Or the capitalist and investor within 
him, rather than the entrepreneur and specu- 
lator, might develop and feel himself drawn to 
increased saving by the prospect of a safe 
interest return. If, however, we may assiune 
that the two rates move in the same direction 
and in such degree as to leave always the same 
margin between them, all classes of savers may 
be regarded as affected in much the same way, 
and one difficulty of the theory under con- 
sideration will be overcome. 

We have seen that the statement of the 
theory of interest in terms of demand and 



THE ABSTINENCE THEORY 6i 

supply leads to some ambiguities in regard to 
the meaning of the word supply. In like manner 
it forces us to employ the term ''demand" in 
a somewhat metaphorical sense in the case of 
the entrepreneur who saves and uses his own 
capital. Can such capital be described as 
supplied in response to a demand except by 
twisting the meaning of the language? Who 
makes the demand? 

Of course these objections to the modem 
form of the abstinence theory are largely formal, 
striking at defects and ambiguities of state- 
ment and the awkwardly hypothetical character 
of its propositions, but not calling into question 
the possibly large measure of truth it may con- 
tain. The pedagogic rather than the scientific 
value of the theory is impugned. Yet in spite 
of the risk of a strained form of statement 
distorting the perspective and throwing minor 
factors into misleading prominence, it would 
probably be maintained by many writers that 
the demand and supply formulation of the 
theory of interest is the most practicable and 
compact form of expression possible. The 
pertinent question is. Does it give an approxi- 
mately true description of the factors at work? 
More cannot be expected from any theory and 
unreasonable demands must not be made of 
the theorist. 

There are, however, objections of a more 
material character which may be made to the 



62 PROFIT AND WAGES 

abstinence theory. It involves two funda- 
mental propositions which analysis will call 
into question. These are: 

First, the total amount of capital rises 
or falls with a rise or fall of the rate of 
profit (or interest). In this manner the 
rate of return to capital is regulated and 
kept from extreme fluctuations. A corol- 
lary indicates that the rate cannot fall to 
zero and the theory thus appears to account 
for the necessity and continuance of interest 
on capital as well as for its rate and amount. 
Second, the changes in the amount of 
capital which are regulative of the rate of 
return are brought about through the 
operations of the marginal savers. 
Granting for the. moment the substantial 
truth of the first proposition, although we shall 
see later that it is not always valid, let us 
examine the second. The validity of this 
proposition is vital to the abstinence theory. 
If changes in the ''supply" of capital regulative 
of the rate of return on capital are not deter- 
mined primarily by the course of marginal 
saving, of saving determined by mental states 
affected by the expected rate of return, then 
the decisive factors must lie on the side of 
* 'demand," or in any case, be of an objective 
rather than of a subjective character. 

Now, to begin with, are marginal savings 
relatively of sufficient amount to have a decisive 
influence on the rate of profit and interest? 



THE ABSTINENCE THEORY 63 

Does the tail wag the dog? There is to be sure, 
no way of deciding definitely what proportion 
of the world's capital owes its existence and 
maintenance to the marginal saver. The statis- 
tician may seek for data in regard to the sums 
which are saved and invested, but there is no 
numerical record of the mental states attending 
such saving. We can be guided only by our 
general impressions. To the present writer 
it appears that whatever may have been true 
in some communities and in the earlier stages 
of capitalism, abstinential, marginal savings are 
today relatively unimportant. They appear 
very small indeed when we set over against them 
— (i) the large accumulations of capital made 
without thought by recipients of large incomes, 
the unspent residua of income of careless, happy 
spenders; such accumulation proceeding at a 
more or a less rapid rate according as the 
larger incomes rise or fall; (2) the impersonal 
creation of capital made by managers of cor- 
porations accumulating surplus out of earnings 
without consulting the willingness of the stock- 
holder to abstain from consumption; (3) the 
stores of capital amassed in the past, which, 
whatever may have been their cost of abstinence 
in the saving, are now maintained inviolate 
from all thought of ever being consumed, and 
incapable, therefore, of decrease except through 
misfortune; (4) the "rainy day" savings which 
would be made even if there were no such 
thing as interest or profit on capital, and (5) 



64 PROFIT AND WAGES 

as factors diminishing the supply of capital, 
the waste and destruction of capital in unpro- 
ductive, unfortunate, or fraudulent enterprises; 
the wreckage of promoter and speculator, and 
the wasteful and destructive armaments of 
military nations. 

Moreover whatever be our estimate of the 
quantity of abstinential saving and of saving 
affected at all by the contemplation of a rate 
of interest, we must make a considerable 
deduction for that portion which proceeds in 
a manner directly contrary to the assumptions 
of the abstinence theory. To some who experi- 
ence the pangs of abstinence a fall of the interest 
rate is the occasion for saving more, not less, 
a rise the occasion for saving less. "As Sargant 
has pointed out," says Marshall, "if a man has 
decided to go on working and saving till he has 
provided a certain income for his old age, or 
for his family after death, he will find that he 
has to save more if the rate of interest is low 
than if it is high."* How large is the deduction 
we must make for saving which proceeds 
contrary to the expectations of the theory, 
there is no way of estimating. It is sufficient 
to make it doubtful what the effect is on absti- 
nential, calculated savings taken as a whole, 
of any change in the rate of interest and profit. 
Three hypotheses may be suggested. First, 
that abstinential savings as a whole rise and 
fall with the interest rate, moving in the same 

*Principles of Economics, 6th edition, p. 235. 



THE ABSTINENCE THEORY 65 

direction. Second, that they move in the 
opposite direction. Third, that the opposing 
tendencies are equal, so that changes in the 
interest rate make no change in the total of 
abstinential saving. Only the first of these 
is in accord with the necessities of the abstinence 
theory. But are we justified in rejecting the 
other two as obviously impossible? And in 
any case can the net resultant of the opposed 
tendencies be of sufficient amount to be con- 
sidered an important factor in determining the 
rate of return on capital?* 

*The consideration of conscious, deliberate, and calculating 
saving alone — leaving out of view the unconscious and imper- 
sonal forces accumulating, maintaining, or wasting capital — 
seems likely to leave one in doubt as to the exact effect of 
a given change in the interest rate. Thus Marshall after 
giving an illustration of the idea we have quoted from him, 
proceeds: "It is then possible that a continued fall in the rate 
of interest may be accompanied by a continued increase in 
the yearly additions to the world's capital. But none the less 
is it true that a fall in the distant benefits to be got by a given 
amount of working and waiting for the future does tend on 
the whole to diminish the provision which people make for 
the future * * * that a fall in the rate of interest tends 
to check the accumulation of wealth." Here we have the 
traditional view of the effect of a fall in the interest rate 
expressed in terms of tendency and "as a whole," while the 
opposite effect is allowed as "possible." The most thorough 
discussion of the mental states of savers is probably that by 
Professor Conner. Conner concludes "alterations in the rate 
operate in different directions. But no positive and universal 
determination is possible, for the forces are irregular and 
exist in no fixed relations. It is, however, clear that it is 
incorrect to say that at a given time there is only one rate of 
interest able to bring about a particular amount of accumu- 
lation. On the contrary, different rates may bring into being 
the same amount of accumulated wealth and capital." Interest 
and Saving, p. 75 ff. 



66 PROFIT AND WAGES 

For the sake of argument let us grant the 
first of the three hypotheses. Then the adherent 
of the abstinence theory is confronted with the 
logical necessity of showing that other factors 
determining supply of capital act in the same 
direction as the marginal savings, in their total 
effect. And, furthermore, if the abstinence 
theory is to be more than a description of a 
very minor factor, if it is to be more than a 
fraction of a complete explanation, it becomes 
necessary to prove that the action of the various 
forces determining the amount of capital other 
than the marginal savings, must be determined 
by the latter. In other words, these other 
forces apparently so much greater in their 
effect than the operations of the marginal 
saver, must be shown to be led or started by 
the marginal saver in the direction in which 
he is going. 

That obviously is an absurdity. What, 
for instance, is the possible relation of the 
marginal saver's worries, to the large quantities 
of capital supplied by those who cannot be said 
to save, for that connotes some thought and 
purpose, but who accumulate large sums by 
failing to spend all they receive? Assume a 
more or less stable standard of living among 
those whose income is large enough to make 
some accumulation of capital habitual and 
continuous, and we can see that changes in the 
rate of accumulation easily follow corresponding 
changes in the volume of income. There is 



THE ABSTINENCE THEORY 67 

no searching of heart and of pocket-book to 
see whether some anticipated though uncertain 
percentage offers sufficient reward for the pangs 
of abstinence. It may be that there is some 
addition or subtraction from the world's total 
of capital brought about by the contemplation 
of the movements of the interest rate, but, 
in any case, the abstinence theory gives an ill 
proportioned picture of what actually takes 
place by its emphasis on savings induced by 
expectations of given amounts of reward. It 
carries the dubious implication that more or 
less of calculating abstention from consumption 
makes a great difference and that the prime 
factor in bringing things to an equilibrium is 
a mental occupation with a future fact, that is, 
with an anticipated rate of gain. Is it not a 
truer view to regard as the moving factor one 
that belongs to the past rather than to the 
future, the fact of increased or decreased income? 
The mainspring of the great movements of 
the supply of capital cannot be found in the 
marginal saver's mind. This is the opinion 
forced upon us when we consider the accumu- 
lations made without thought and effort out 
of large incomes. In like manner we fail to 
find any discoverable connection between painful 
abstinence calculations and the reservations 
for surplus made out of the earnings of large 
corporations or even of smaller business units. 
And what have considerations of abstinence to 
do with maintaining in the face of any fall of 



68 PROFIT AND WAGES 

the interest rate yet experienced, the capital 
sums once saved? What pang of abstinence 
could ordinarily be balanced against the grief 
of parting with capital? And finally when we 
come to the various forces wasting and destroy- 
ing capital, as they manifest themselves espe- 
cially in times of crisis and of war, we may 
confess our inability to give a full explanation 
of their appearance, and yet have no hesitation 
in declaring that the marginal saver's states 
of mind count for nothing in these affairs. 

If the calculations of the marginal saver are 
not the mainspring of the great forces deter- 
mining the amount of capital in the world, the 
abstinence theory fails as an explanation of 
the quantity and rate of capitalist income. Our 
argument has led to the conclusion that no 
simple, easily formulated psychological factor 
can account for increase or decrease of capital. 
The prime factors must be objective. How 
large is the product of industry and how much 
of it is left after wage earners and other recipients 
of small pay have drawn their share? In other 
words what is the income in the shape of rent, 
interest, and profits out of which capital is 
accumulated? Out of which it may almost be 
said to accumulate itself. And what are the 
factors determining the waste and destruction 
of capital, the only factors capable of causing a 
positive decrease in the total of capital and not 
merely a slackening in the rate of its increase? 
Such are the overwhelmingly important forces 



THE ABSTINENCE THEORY 69 

making the supply of capital what it is. They 
act in entire independence of the marginal 
saver's supposed balancing of the cost of absti- 
nence against the attractions of an anticipated 
reward. They are objective rather than sub- 
jective factors and will not fit the logical neces- 
sities of the abstinence theory. And it may be 
added, they are equally recalcitrant to the needs 
of the time-preference theory. It matters 
nothing to the argimient whether we speak of 
the cost of abstinence or the cost of waiting, 
the reluctance to abstain from consuming or 
the reluctance to postpone consumption. The 
fact is that no unobjectionable formulation of 
the process we are trying to explain is possible 
in terms of anything psychological. 

It appears to the writer that sufficient grounds 
have been given for rejecting the abstinence 
theory and its possible variants. Some con- 
sideration, however, may be given to the 
question whether marginal savings move with 
the greater forces determining supply of capital 
and in the same direction. Or, to state the 
question with a different emphasis, do the great 
forces other than the marginal saver's operations, 
act in the same direction in response to changes 
in the rate of interest and profit as the marginal 
savings, assuming the latter to act as described 
by the abstinence theory? In that case, although 
neither of these two sets of factors determines 
the other, the fact of their being more or less 
synchronous and parallel, would make it possible 



70 PROFIT AND WAGES 

to maintain that the abstinence theory describes 
a part of the forces determining supply of capital, 
though a very small part, and that as long as 
we care only for the direction of change and 
not for the amount, the abstinence theory 
could predict correctly what will happen under 
given conditions. However, not even that 
slight concession may be made to the value of 
the theory. It isn't true that the decisive 
factors always and necessarily increase or de- 
crease the total of capital according as the rate 
of interest and profit rises or falls. These 
factors may at times act in that manner, and 
thus prevent large fluctuations in the rate 
of return on capital, but, as will appear, such 
is not their invariable action. In fact it is not 
possible to formulate any "law" or simple 
general proposition in regard to the influence 
of the rate of interest or profit, on increase or 
decrease of capital. 

Leaving out of view the marginal saver and 
giving attention only to the great and decisive 
factors determining supply of capital, let us 
ask first what happens when the rate of interest 
and profit goes up. Usually we may expect 
an increase of capital. This will be at an 
accelerated rate if the rise in the rate of interest 
and profit indicates a rise of the total of interest 
and profit; if, for instance, there has been a 
great advance in productive efficiency, or in- 
creased opportunities for the exploitation of 
new lands or cheap labor. In that event there 



THE ABSTINENCE THEORY 71 

will be a rapid accumulation of capital in the 
shape of unspent residua of income and large 
reservations for capital use out of gross profits 
by business managers. At such times it may 
almost be said with truth that the opportunity 
for large gains creates the capital to exploit 
the opportunity. A less rapid growth of capital 
may occur when the higher rate of interest and 
profit indicates the higher productive margin 
at which destructive influences, as for instance 
a great war, have left the diminished total of 
the world's capital. In spite of the high rates 
the total income in the shape of interest and 
profits is less than before and the rate of growth 
of the total capital will, therefore, probably 
be less. Whether slowly or rapidly, however, 
the total of capital may be expected to grow 
when the rate of return goes up. And yet this 
is not the inevitable outcome because there 
may come into play the forces wasting and 
destroying capital, forces so unpredictable and 
erratic as to have the appearance of extraneous 
and accidental factors from the view point of 
economic theory. 

If the movement of capital in response to 
a rising rate of interest and profit is, on the 
whole, in accord with that assumed, though not 
correctly explained, by traditional economic 
thought, the same cannot be said of the results 
of a fall of the rate of capitalist gain. If, what 
is the most probable case, the fall in the rate of 
return is due to the lowering of the productive 



72 PROFIT AND WAGES 

margin brought about by the increase of capital, 
the total of income in the shape of interest and 
profit has been increased. New supplies of 
capital seeking investment receive only a low 
rate but the recipients of interest, profit, and rent, 
as a class, are wealthier than before. The 
accumulation of new capital out of these incomes 
might therefore be expected to continue in 
greater rather than in lesser volume. 

The case of a lowered rate signifying a general 
decline in productive efficiency and, therefore, 
a decrease of the total of incomes in the shape 
of interest and profit, is so purely hypothetical 
and remote from our experience, that it seems 
hazardous to speculate concerning it. Capital 
might simply show a decreased rate of growth. 
There would probably still be some saving for 
a rainy day. And even if the total of capital 
did not increase there need be no decrease. 
The large capital accumulations of the past 
might be jealously guarded against the desires 
of spendthrift and consumer. The same con- 
siderations probably apply to the case of a 
general diminution of interest and profit brought 
about by labor gaining a larger proportion of 
the total product of industry. In fact all 
conceivable conditions seem to include some 
saving, that is, some addition to the stock of 
capital, and a holding on to what has once 
been saved. 



THE ABSTINENCE THEORY 73 

Whatever conditions we assume, it seems 
difficult to prove any probable, positive decrease 
in the total of the world's capital. In what 
appears for an advanced industrialism the 
most likely cause of a decline in the rate of 
capitalist return, that is the lowering of the 
margin of investment brought about by the 
increase of capital itself, the result is an accel- 
erated increase in capital. But if such is the case, 
what keeps the rising tide of capital from 
forcing the marginal rate of profit downwards 
until it vanishes from sight? What makes the 
continuance of the capitalistic system itself 
possible? 

Economists apparently have not given much 
consideration to the distressing thought of a 
rate of profit reduced to zero. The classical 
writers, however, frequently raised the question 
as to what agencies resisted the strong ' 'tendency 
of profits to a minimum." First among these, 
says Mill, is "one which is so simple and so 
conspicuous, that some political economists, 
especially M. de Sismondi and Dr. Chalmers, 
have attended to it almost to the exclusion of 
all others. This is the waste of capital in 
periods of over-trading and rash speculation, 
and in the commercial revulsions by which such 
times are always followed."* To "over-trading 
and rash speculation" we may add the destruc- 
tion and waste of capital by militarism. The 
second of the "counter-agencies" according to 

*Principles of Political Economy, Book IV, Chap. IV. 



74 PROFIT AND WAGES 

Mill is "improvements in production." So far 
it appears that capitalism is saved by waste and 
progress. A third factor, mentioned by Mill, 
"the perpetual overflow of capital into colonies 
or foreign countries," indicates that the day 
of reckoning may be postponed by the extension 
of capitalism into new territory. 

Thus either by the destruction of the super- 
fluity of capital, or by the enlargement of 
opportunities for investment through invention 
or geographical expansion, the rate of interest 
and profit is kept alive. We shall not undertake 
a thorough examination of the extent to which 
the fall in the rate of capitalist return itself 
calls out these counteracting forces. That a 
low rate of interest stimulates speculation and 
unsafe enterprises is fairly obvious. The in- 
fluence of the over-accumulation of capital on 
governmental expenditures and imperialistic pol- 
icies is no secret. Of the restlessness of a world 
forced to seek an ever expanding field for 
investment we have abundant evidence. The 
worry of our age has been its redundant capital. 

Our discussion has shown the impossibility 
of formulating any simple general law in regard 
to the response of capital supply to a changing 
rate of return. There is no definite supply price 
in the shape of a rate of interest for any given 
amount of capital. On the whole a rise in the 
rate of return tends to be followed quickly by 
an increased supply. On the other hand, a 
fall in the rate of return may find no immediate 



THE ABSTINENCE THEORY 75 

check. When finally checked it is by such 
forces as an expansion of the capitalistic area, 
progress and invention in productive methods, 
and large waste and destruction of capital. 

The views in regard to the supply of capital 
which we have set forth, lack the attractive 
simplicity of the abstinence theory. But that 
simplicity, like the excessive rationalism of the 
time-preference theory, is not found in the 
actual phenomena. The theory supposes a 
more refined and persistently followed utilitarian 
calculus than seems probable or possible to 
real human beings. The writer does not deny, 
of course, that there may be serious reflection 
on the question of spending less and saving more. 
To a rationalistic view the utility of saving 
might appear to be increased every time the 
interest rate moves upward a little. But is 
the problem of the relative attractions of saving 
and spending raised in anybody's mind every 
time the interest rate changes? Are not such 
considerations rather occasional? They help 
to establish habits of spending or saving a 
certain amount. Then if the income out of 
which saving is made rises, an increased "saving" 
takes place without thought of what rate of 
interest may be obtained by it. 

To be sure it is conceivable that very great 
and sudden changes in the rate of return might 
shake people out of their established habits 
into deliberately saving more or less. If the 



76 PROFIT AND WAGES 

rate, for instance, were suddenly to jump to 
twenty per centum, saving would have attrac- 
tions it never had before. A sudden drop to 
one-tenth of one per cent, would have most 
disturbing and unpredictable effects on those 
who had hitherto been in the habit of saving. 
But do changes of such amount as experience 
teaches us to expect, lead to new calculations 
of how much we may save or spend every 
time they occur? When the rate rises from, say 
four per cent, to four and a fraction, or even 
to five ; or falls from four to three and a fraction, 
or even to three per cent, how many are there 
who form new resolutions? An expected return 
on investment of some kind may give an induce- 
ment to saving, a support to the habit of saving, 
— for some persons, a general reason for saving 
at all. But that does not mean that different 
definite rates of prospective return directly 
determine the amount of saving and maintenance 
of capital. The implication of the abstinence 
theory that expected rates of return have 
this definite determinative effect is an unproved 
assiunption. But even if the painful calculations 
of some marginal savers pursue the course 
described by the exponents of the abstinence 
theory, are they of sufficient consequence to 
make any real difference? Are not their con- 
tributions to the current supply of capital so 
insignificant compared with those from other 
sources, that a general theory of the income of 
capital is warranted in disregarding them? 



THE ABSTINENCE THEORY 77 

The great factors determining the supply of 
capital we may call, for lack of a better term, 
objective, in contrast with the subjective deter- 
minants set forth by the abstinence and time- 
preference theories. Set over against these 
objective forces, the calculated, abstinential 
savings appear, to the extent of their tenuous 
being, a mere epiphenomenon of our modem 
industrial system. 

If the view just presented gives a substan- 
tially true picture of what takes place in the 
existing world of capital accumulation and 
investment, it follows that the theory of the 
rate of interest should aim first to account for 
what we have called the objective factors. 
It should inquire into what determines the 
opportunities of a gainful use of different 
amounts of capital, i. e., it should give us first 
of all a theory of the origin and rate of profit. 
In doing this it will be well to avoid metaphor 
and not to speak of a ''demand" for capital. 
A large amount of capital never changes hands 
and there is no question as to who is to use it 
and upon what terms. It is neither demanded 
nor supplied. It is merely owned and used. 
When the rate of profit has been accounted 
for, theory may proceed to the problem of the 
rate of interest, the problem of how profit is 
divided between capitalist and entrepreneur. 

The more fundamental problem of the rate 
of profit which makes possible a rate of interest, 
cannot be stated satisfactorily in terms of 



78 PROFIT AND WAGES 

demand and supply. Theory may recognize 
that the amount (not the supply) of capital is 
a determinant of the rate of profit, and also 
that saving affects that amount and thereby 
the rate of return. But saving should not be 
put forward as a factor acting independently 
or as being quantitatively determined by factors 
independent of and distinct from the objective, 
technical or business factors, which make the 
rate of profit. In other words, saving should 
not be represented as determined by subjective 
factors. While such factors may affect some 
saving, the decisive, regulative changes in the 
supply of capital cannot be attributed to them. 
The actions and purposes which determine 
conscious saving, the calculations of abstinence, 
such as they are, cannot be co-ordinate in 
importance for the theory of profit, with the 
facts which determine the gains of capital. 
There is no bargain made in saving. The 
saver as such has nothing to say in the matter 
of making capital yield a profit. It is the users 
of capital, their skill and opportunities, that 
really signify. The usual demand and supply 
formulation of the abstinence theory, by giving 
to saving and abstinence on the one side, an 
appearance of as great importance as that of 
the objective factors on the other, gives a 
misleading perspective to all the factors at 
work. The habit of thinking in terms of demand 
and supply has its drawbacks. We need to 
break away from the see-saw of demand and 



THE ABSTINENCE THEORY 79 

supply to reach a just appreciation of the 
relative importance and direction of the forces 
which make the existing amount and rate of 
capitalist income. 

The objection to the abstinence theory coming 
especially from socialistic quarters, that the 
large capital accumulations of the rich are 
subject to no cost of abstinence, was apparently 
met by limiting the significance of abstinence 
to the marginal saver. But this answer, we 
have seen, is not conclusive. It was not proved 
by the adherents of the theory that abstinential 
savings are of sufficient amount to be in any 
way regulative of the rate of interest. The 
capital which comes without abstinence, with 
its larger volume and more rapid changes, 
leaves the tendencies and effects of abstinential 
savings a purely secondary movement, of imper- 
ceptible influence on the actual rate of capital- 
istic income. We need not look to the abstinence 
theory for any clear light on the problem of 
the amount and rate of interest and profit. 
It fails as fully as the time-preference theory 
to show primarily subjective factors as the 
direct determinants of the rate of income. 

Our criticism of the abstinence theory has 
aimed to show that it fails to account for the 
amount and rate of return on capital. There is 
the further question as to why there is interest 
at all. Why is it possible to obtain an income 
without labor? Whether an answer to this 
question entirely satisfactory to all students 



8o PROFIT AND WAGES 

can ever be given seems somewhat doubtful. 
In any case, among the data necessary to an 
explanation of the existence of the institution 
of interest there are legal and historical factors 
with which economic theory is not fitted to 
cope. Now it may be granted to the abstinence 
theory that it has brought to light, in the cost 
character of the abstinence necessary to some 
saving, one of the conditions essential to the 
existence of interest. If saving involved no 
sacrifice, the volume of capital would rise to 
the point of making interest impossible. Capital 
would be free to all. But if it should cost 
nothing to save, it is evident that income must 
consist of "free goods." The character of the 
abstinence involved in saving is, therefore, not 
only one of the conditions of the appearance 
of the institution of interest but of practically 
all economic life. It is a proposition of such 
general character that it seems pedantic to cite 
it at all instead of taking it for granted. How- 
ever, we need not object if an explanation of 
the existence of capitalist income should take 
some cognizance of the fact that capital depends 
on saving, and that because our income consists 
of "economic goods" and not of "free goods," 
saving involves abstinence. But if we seek 
an explanation of the existing amount of cap- 
italist income, the consideration of abstinence 
and in general of subjective factors, is of slight 
advantage. We may grant too that the con- 
cept of abstinence may play some part in 



THE ABSTINENCE THEORY 8i 

capitalistic apologetics. With that however 
we are not here concerned. The obviously 
important facts for the purposes of the theory 
we are seeking, are not subjective but objective 
in their nature; and to these our attention 
must now be directed. 



CHAPTER V 

THE PRODUCTIVITY THEORY OF INTEREST 

When we turn to the study of the objective 
factors of the process of capitahstic production 
and distribution, we are confronted by various 
attempts to deduce interest from the "produc- 
tivity of capital." These productivity theories 
differ in clearness and expository detail, in the 
extent and manner of combination with other 
theories, and in the definition of capital taken 
as a starting point. The most popular form 
operates with a conception of capital as a 
group of concrete goods used as instriunents of 
production. With such instriunents, if of the 
right kind, labor obviously can produce more 
than without. This excess of product is imputed 
in more or less metaphorical language to the 
concrete capital goods, and the assumption is 
made that it corresponds in some way with the 
amount of income that the capitalist normally 
receives from the use of his capital. 

Two problems are presented by this form of 
the theory. First, how can the part due to 
capital in the joint product of capital and labor 
be marked off from that due to labor? And 
secondly, how can we ascertain what part of 
the product imputed to capital is to be regarded 
as replacement of the capital used up and what 
as net remainder may be stated as a percentual 



THE PRODUCTIVITY THEORY OF INTEREST 83 

return upon that capital? Or in other words, 
as it is the value of the capital itself which must 
be deducted from the part of the product 
imputed to capital, how is that value determined? 
To determine the product to be imputed to 
capital it would apparently be necessary to 
know what labor can produce without capital. 
If all excess of product above this, no more and 
no less, is to go to the capitalist, wages would 
have to be just equal to what the labor employed 
could have produced without the aid of capital.* 
It does not appear to be easy to determine 
precisely what that amount would be. Nor 
does this determination of wages appear probable 
when applied to certain grades of labor. It is 
pretty clear, for instance, that many kinds of 
skill and ability would be of very little use 
outside of capitalistic industries. If it were 
true that labor gets only what it could produce 
without capital, then skilled labor, on the whole, 
would receive the lowest wages paid in any 
industry. It would be inexpedient to take up 
the consideration of the theory of wages at this 
point, but it should be noted that the inter- 
pretation of the productivity theory just given 
suggests a view of wages that cannot be brought 
into accord with any of the theories of wages 
prevailing at present. Moreover, its implication 
that none of the productive advantages of 

*To avoid complications of statement, differential profit and 
rent are omitted from consideration at this point and through- 
out our discussion of capitalist income. The problem is that 
of the division of marginal product. 



84 PROFIT AND WAGES 

capitalism go to the wage-earner would not be 
very attractive to most exponents of the pro- 
ductivity theory. 

The form of the theory now most in favor, 
however, does not clearly impute to capital the 
total of product in excess of what labor unaided 
by capital could produce, but only an amount 
depending on a rate determined by the pro- 
ductivity of the last and least productive unit 
of capital taken on. This "marginal" rate 
forced upon the entire amount of capital leaves 
that part of the product of the earlier incre- 
ments which is in excess of this rate, as something 
that does not go to the capitalist but to some 
other "claimant" in the distributive process — 
to the landowner, or to the entrepreneur, or 
to the laborer. This method of calculating 
imputed returns is also applied to labor. Alter- 
nately injecting now a "dose" of capital, now 
of labor, we are asked to observe the productive 
effect of each to get its "specific productivity" 
and rate of payment. It is to be noted that 
the dose must be a homeopathic one. A large 
increment of either factor would necessarily 
call for a simultaneous increase in the other. 
In that case the additional product obtained 
would be a joint product of capital and labor, 
not a "specific" product of either, and there 
would be no way of ascertaining what pro- 
portion of it should be imputed to each. This 



THE PRODUCTIVITY THEORY OF INTEREST 85 

gives an air of extreme unreality to the theory 
in question. Is the calculus of small doses a 
possibility in the conduct of actual business? 

Granting, however, for the sake of argument, 
that in some way, the return to be attributed 
to capital can be calculated, the popular specific 
productivity theory is next confronted with 
the difficulty of the second problem mentioned 
above, the problem of determining the value 
of the capital. Critics of the theory have shown 
conclusively that it fails at this point. How 
can you compare the product with the capital 
to which it is imputed in such manner as to 
ascertain a percent ual rate of return? The 
goods produced and the "capital" that "pro- 
duced" them are of unlike physical character 
and, therefore, incommensurable. How can 
you express yards of textiles as a percentage 
of the looms from which they have issued? 
Physical measurements give no basis of com- 
parison. Evidently we must resort to market 
values. If we ask how the capital good gets 
its market value, we are told by modern econo- 
mists that it is derived from its product. But 
why is not the value of the capital good equal 
to its entire product? Why is there in the 
value of the product a surplus called interest? 
Because, for some reason, the entrepreneur 
will not pay for the capital good more than the 
discounted value of its products. It appears, 
therefore, that the discount and interest rate, 
which the productivity theory represents as 



86 PROFIT AND WAGES 

arising from a comparison of values, is assumed 
in getting the value of one of the terms of the 
comparison, — an obvious case of circular rea- 
soning. This objection to the popular form of 
productivity theory is a logical inference from 
a theory of value that regards demand based 
on estimates of utility on the part of buyers, 
as the chief, or one of the chief, determinants 
of value. It is hard to see how those who hold 
the Austrian theory of value can accept a pro- 
ductivity theory of interest while defining capital 
as concrete goods used as instruments of pro- 
duction. 

If instead of looking forward to the product 
for the source of the value of the capital good, 
it be permissible to look backward to its expenses 
of production, a productivity theory based on 
the concept of capital as consisting of concrete 
goods, would still be exposed to the criticism 
that it is reasoning in a circle. A view of the 
entire process of production shows the invest- 
ment of capitalists and entrepreneurs, as a class, 
to consist of advances to labor. If we might 
assume these advances, that is wages, deter- 
mined in some way independently of the product 
of capitalistic industry (by the "cost" of labor, 
for instance) we should get a value for capital 
with which the net product might be legitimately 
compared in calculating the percentual rate 
of return. But the theory we are considering 
confines the term capital to concrete goods used 
in the later stages of production. The price 



THE PRODUCTIVITY THEORY OF INTEREST 87 

of these goods includes not only payment for the 
labor employed in making them, including the 
labor of all the preparatory stages, but also 
accumulated interest and profit. Obviously 
it is not possible to get the value of the capital 
good without assuming a rate of income upon 
capital. Whatever method this theory takes 
of accounting for the value of capital goods, 
involves it in a vicious circle. 

We might therefore regard the theory we have 
just considered as disposed of, and pass on to 
other variants of the productivity theory. It 
is desirable, however, to point out some diffi- 
culties arising from the restricted concept of 
capital employed by this theory. Obviously 
the entrepreneur expects to gain at least the 
rate of interest from all of his business outlays, 
not merely from what he spends for "capital 
goods," but also from his expenditures for labor. 
The exponents of the specific productivity theory 
say nothing about the interest earned by the 
employer's pay roll. Yet the fact of this 
interest cannot be denied. Or, is it an illusory 
phenomenon? Could it be argued that all 
interest grows out of capital goods alone but 
that it is spread as a uniform rate over the entire 
investment of capitalist and entrepreneur? If 
this were the case, the actual rate known to 
business men would be smaller than the rate 
of productivity of the capital goods, and the 
productivity theory, while indicating the source 
of interest, would stand in need of further 



88 PROFIT AND WAGES 

development to explain how the actual rate of 
interest is established. The problem confronting 
the productivity theorists would be the inverse 
of that met by Karl Marx. To obtain the rate 
of profit Marx had to show how the surplus 
value due only to "variable capital," i. e., to 
what is paid for labor, is assigned to and ex- 
pressed as a percentage of, the total investment, 
of both ''constant" and variable capital. The 
productivity theorist would have to meet the 
problem of spreading a surplus from the use 
of the "constant" capital, the concrete capital 
goods, over the entire capital, variable and 
constant. Unlike Marx they have made no 
effort to solve their problem. 

Or may interest on the wages fund be regarded 
as a derivative income? Could it be argued, 
in a manner analogous to the reasoning of the 
fructification theory, that, because the capitalist 
can obtain interest from capital goods, he will 
refuse to buy labor except at a discount which 
will yield him the same rate of interest? But 
capital goods have no productive value unless 
served by labor and the entrepreneur could not 
refuse to buy labor and turn entirely to capital 
goods. If, under such conditions, labor submits 
to a discount, that fact needs to be explained. 
The productivity theory suggests no explanation. 

Such are some of the difficulties of the form 
of the productivity theory which we have been 
considering. They arise out of the restricted 
conception of capital. The usage of the business 



THE PRODUCTIVITY THEORY OF INTEREST 89 

world is to regard all outlays whether for labor 
or for "capital goods," as an investment of 
capital and to expect or hope for a return in 
profit or interest on every part of the invest- 
ment. In taking capital in the sense of concrete 
instruments of production, the theory fails to 
take account of important interest-yielding 
investments. Moreover, this restricted con- 
cept of capital, limits the view to one segment 
of the long process of capitalistic production. 
It has nothing to say about the labor that made 
the "capital good," the machine, for instance, 
nor the conditions under which that labor was 
employed. It does not go back to the beginning 
of the productive process, but fixes attention 
on one of the later stages in asking what is 
added to total product by the use of a given 
capital good. It proceeds, in the language 
of Bohm-Bawerk, as if the capital had dropped 
from heaven. A theory operating with such 
a restricted concept of capital must be expected 
to come to grief. 

But now we may inquire whether taking 
into consideration every class of investment 
directly connected with productive industry 
and viewing the process of production as a 
whole and not by detached portions, a pro- 
ductivity theory may be constructed that can 
escape the pitfalls in the way of the ordinary 
productivity theory and meet the demands 
that must be made upon a complete theory. 



90 PROFIT AND WAGES 

If we view the productive process as a whole, 
it appears that we have nothing before us but 
human labor acting upon the physical world. 
There is no capital as a distinct productive 
factor. The investment of the capitalist and 
entrepreneur, the "use of capital" regarded 
from the point of view of production, is nothing 
but a special way of applying labor, — the 
"round-about," indirect, capitalistic way. And 
while nothing but labor is used, nothing is 
paid out by the entrepreneur in his business, 
nothing is "invested," that is not looked upon 
as capital. If, however, we regard the entire 
process, entrepreneurs as a class appear to 
pay out nothing but wages. It is only between 
members of the class of entrepreneurs, between 
those in control of the different segments of 
the process of production of any commodity, 
that payments are made for anything that is 
not labor. The purchase and sale of "inter- 
mediate goods" necessary in making the con- 
sumable goods which are the ultimate outcome 
of an extended process, is a purely intra-class 
affair. As such these transactions are only a 
method of dividing up the investment and the 
gains of capital in an extended process. In a 
comprehensive view of the process of production, 
there are, therefore, no separate outlays for 
labor and for capital. How then can one 
distinguish a "specific product" of capital? 



THE PRODUCTIVITY THEORY OF INTEREST 91 

How trace any such connection between product 
and the return of capital as would justify us in 
formulating a productivity theory? 

In the attempt to make out a productive 
return in some way imputable to capital, one 
might be disposed to point to the fact that the 
capitalistic, indirect method of applying labor 
gives a larger productive result than the non- 
capitalisitc, direct use of labor. This is not 
saying merely that labor with tools can produce 
more than labor without tools. It means that 
a given quantity of labor will yield a larger 
result if some of it is used to make tools than 
if all of it were used without such helps. That 
the productive advantage of the capitalistic 
process, the surplus of product it can yield 
above that given by an equal amount of labor 
used in non-capitalistic ways, is an important 
source (if not the only one) of the income of 
capitalist and entrepreneur, is a statement 
not likely to meet with contradiction. Whether 
the amount of this surplus can be definitely 
ascertained or not, whether all of it goes to 
capitalist and entrepreneur, or whether the 
laborer may receive a portion of it, whether 
capitalist and entrepreneur are restricted to it 
or can derive gains from other sources, it seems 
pretty certain that such a large part of the 
income of capital is drawn from this surplus of 
product, that if there were no such surplus, 
capitalism as we know it, could not exist. 



92 PROFIT AND WAGES 

The recognition of the superior productive 
power of the capitahstic process as a condition 
necessary to the existence of profit and interest, 
does not, however, give us a complete theory 
of profit and interest. There remains to be 
explained the process by which a percentual 
rate is brought about and of course the explana- 
tion may not assume this rate. The time- 
preference theory would account for the rate 
by an appeal to subjective factors. The pro- 
ductivity theory, however, or any theory based 
on objective factors, must show the value of 
the investment, the ''capital" as determined 
in some way independently of the discounted 
value of the product. Can any conceivable 
productivity theory meet these demands? 

At this point we need to consider a version 
of the theory which perhaps may come to be 
the authoritative one for many who hold the 
faith. It is suggested by some passages in 
Bohm-Bawerk's writings and may be picked out 
in fairly definite form from the eclectic theory 
of Landry. Its basis is not the productivity 
of particular concrete capital goods, but rather 
the productive advantage of an extension of 
the "production period," or if you will, the 
productive advantage of a longer process of 
production as compared with any shorter one. 
Successive investments taking such a form as 
to result in extensions of the production period, 
bring about an increase of return, at least 
within certain limits, over and above what 



THE PRODUCTIVITY THEORY OF INTEREST 93 

could be produced in a shorter process. If we 
may suppose different methods of producing 
the same commodity, some more capitaHstic 
than others, or to put it in other words, if we 
suppose productive processes of different length 
in the same industry, the investment necessary 
to pass from the less to the more capitalistic 
method, from the shorter to the longer process, 
may have imputed to itself the increase of 
product realized.* There remains to be 
accounted for the persistence of the older and 
less capitalistic methods, the relatively under 
equipped establishments existing side by side 
with the superior. There is to be explained 
the failure of some of the better equipped even, 
to reach the maximimi of efficient equipment 
which the technical knowledge of the time 
seems to make possible. Why does not the 
most effective form and degree of equipment 
known become general throughout each industry? 
The answer given is, "Because of the insuf- 
ficiency of capital available," capital appearing 
to mean chiefly the means of supporting labor, 
in the long drawn out, capitalistic processes 
of production. Because of this lack of capital, 

*The word "method" is used for the sake of brevity. There 
need not, however, be a distinct difference in general method. 
The difference thought of is rather in the degree of equipment 
with some of the results of the earlier stages of a long process, 
i. e., it is a difference in the length of the "production period" 
as measured by Bohm-Bawerk (Positive Theory, Book II, 
Chapter II). When, however, this difference reaches a certain 
degree, it becomes difficult to think of it as only quantitative 
and not as a qualitative one, i. e., it becomes a difference 
in method. 



94 PROFIT AND WAGES 

there remain abundant opportunities for gainful 
extensions of the productive process and the 
gains must fall to the owners of capital. 

This assumption of a normal insufficiency of 
capital is somewhat open to question. It is 
in conflict with the obvious redundancy of 
capital which appears from time to time. If, 
indeed, Bohm-Bawerk were right in thinking 
the rate of product capable of indefinite increase 
through lengthening of the "production period," 
there never could be capital enough to exploit 
fully the endless succession of productive oppor- 
tunities. Bohm-Bawerk's idea, however, we 
have seen is erroneous.* There are limits, 
perhaps quickly reached, to the productive 
possibilities of employing additional capital 
in extending the production period. In conse- 
quence it is quite conceivable that in a time 
of rapid increase of capital, there may be, not 
only no lack of capital, but an excess. The 
persistence of relatively ill -equipped establish- 
ments and of unexploited opportunities in the 
face of such abundance of capital can be ex- 
plained in large part by reference to factors 
which economists are wont to group under the 
title of ''friction." Capital is not a perfect 
fluid inevitably finding its own level and filling 
every depression. And not all productive 
opportunities are controlled by men of sufficient 
ability and credit to command all the capital 
which might be advantageously employed. A 

*See footnote, page 24. 



THE PRODUCTIVITY THEORY OF INTEREST 95 

plethora of capital may, therefore, obtain, at 
least, in a temporarily static or unprogressive 
society. In a dynamic stage of industry, 
progressive inventions will, for a time, create 
opportunities in excess of what the capital 
available can exploit; although, as we have 
seen in the preceding chapter, the opportunity 
for large capitalistic gains may rapidly create 
the necessary supply of capital. A dynamic 
state appears, therefore, to be a necessary 
assumption of the productivity theory which 
we are at present considering.* It is not a 
theory applicable to static conditions. 

The formulation of the productivity theory 
we are considering, has some points of super- 
iority over that which operates with the notion 

*This suggests the theory recently advanced by Schumpeter, 
some comment on which may be introduced at this point. 
Accepting Clark's argument that in a static state there is no 
"waiting," and that the agio theory is, therefore, inapplicable; 
accepting also Bohm-Bawerk's refutation of the specific 
productivity theory of interest and of the abstinence theory, 
Schumpeter concludes that interest on capital in a static 
society is inexplicable and hence impossible, and that the 
explanation of the appearance of interest must be sought in 
dynamic factors. To the present writer a fundamental defect 
in Schumpeter's views is found in his theory of wages. No 
static society such as Schumpeter supposes ever existed or 
could exist, but if it is permissible to the imagination to con- 
struct such a state, why not make one in which the unchanging 
supply of capital (acting as a "wages fund") is not sufficient 
to raise wages to the full product of labor? In that case there 
would be interest on capital. However, the concept of an 
entirely static state is full of pitfalls and had best be avoided 
by the theorist. It is frequently necessary to think of a par- 
ticular group of conditions in static terms, and such has long 
been the practice of economists. But Schumpeter is wrong 
in thinking that his construction of a complete and entirely 
static state is a logical continuation of the classical tradition. 



96 PROFIT AND WAGES 

of capital as consisting of instruments of pro- 
duction. In its use of concepts made familiar 
by Bohm-Bawerk it presents a view of the 
productive process as a whole instead of viewing 
it by segments. But on closer examination it 
appears to be only a different formulation of 
the theory of marginal productivity. An exten- 
sion of the productive process means that a 
larger proportion of the total labor employed 
is used in the preparatory process of making 
and perfecting instruments of production. Labor 
in the later stages will therefore become equipped 
with more instruments, and the full productive 
advantage, the greater quantity of consumable 
goods, resulting from this rearrangement of 
the proportions of labor employed at the 
different stages in the production of commodi- 
ties, will not appear until the additional instru- 
ments have been used. Now it shows a better 
understanding of what is fundamental to attri- 
bute the increase of product to the investment 
making possible an extension of the production 
period, rather than to the capital goods which 
are the results of this investment. But it 
doesn't after all give us an essentially different 
theory. Like the more familiar formulations 
of the productivity theory this version also 
represents the rate of interest as determined 
by the gains of the additional or marginal 
increments of investment. And like them it 
fails to give a satisfactory answer to the question 
as to what determines the value or price of 



THE PRODUCTIVITY THEORY OF INTEREST 97 

what is invested. Assuming the value of labor, 
like that of other productive goods, to be the 
discounted value of its product, it assumes 
what it should explain. Viewing the productive 
process as a whole it suggests that the only 
investment made by capitalists as a class is 
what is advanced to labor in the form of wages.* 
Now if wages, the price of labor, could be 
shown to be determined independently of the 
discounted product of labor, the way would be 
open to demonstrating an income as a percentual 
rate of interest upon an independently deter- 
mined capital value. This way, however, is 
closed to the productivity theorists by the 
theory of wages held by them. 

It does not appear that any form of produc- 
tivity theory has as yet been able to account 
in a satisfactory way for the rate of interest. 
Yet there must be some truth, or something 
exercising the attraction of truth, at the bottom 

*B6hm-Bawerk includes "uses of land" (Bodennutzungen). 
There is no "price of the uses of land," that is no rent, at the 
margin, and following our plan of viewing the problem as that 
of the division of the marginal product only, we might dis- 
regard the difficulties which would arise for the productivity 
theory from the attempt to include rent in the investment. 
If rent is paid at the end of the productive process, as a share 
of the product, it creates no difficulties for the productivity 
theory. If paid in advance, it supposedly equals the discounted 
value of the product assigned to it. In that case there enters 
the illegitimate assumption of a discount rate already estab- 
lished. It may be remarked in this connection that the con- 
cept of a price of uses of land, employed by Bohm-Bawerk 
and Schumpeter, is an unfortunate substitution for the older 
concept of land rent. It conveys the misleading suggestion 
that different quantities of uses of a given piece of land may 
be bought at a given point of time. 



98 PROFIT AND WAGES 

of such persistently recurring ideas as those 
formulated, in one way or another, in the 
various productivity theories. Capitalism is 
more productive than labor not aided by 
capital. To the writer it appears that the 
form of productivity theory we have just 
examined, the theory suggested by Bohm- 
Bawerk and Landry, has some elements neces- 
sary to a complete explanation of profit and 
interest, and that with one important modifi- 
cation or addition, it can be converted into, or 
led over into, the most satisfactory solution 
of the problem at present attainable by the 
method of abstraction and general theory. 
The necessary modification is to be reached by 
the way of a theory of wages. Before pro- 
ceeding to the formulation of a theory of profit 
and interest, it will be well, however, to call 
to mind just what is the nature of the problem 
before us. 



CHAPTER VI 

THE ESSENTIALS OF A THEORY OF PROFIT AND 
INTEREST 

To make income appear as interest, it must 
be expressed as a proportion or percentual 
rate. Profit of capital too is to be stated as a 
rate. If it were not calculable in this form, 
the entrepreneur would not know what to bid 
in his bargain with the capitalist, and the 
capitalist would be ignorant of the business 
value of what he had to offer. The existence 
of a rate, however, pre-supposes two values, 
(i) the income that is calculated as a rate 
and (2) the capital sum of which the income 
is to be stated as a percentage. Let the rate 
be represented by R, the net income by I, 
the capital by C. Then 

I = CR 
This equation gives us three quantities of 
importance in the theory of interest. A fourth 
significant quantity, the gross income, rep- 
resented by F, is given in the equation 

i=r+c 

Having four quantities in two equations, it 
will suffice to know two of the four in order 
to calculate the others. The theory of interest 
need not, therefore, explain the quantitative 
determination of more than two of these quan- 
tities. These, however, must be capable of 
calculation independently of the other two. 



loo PROFIT AND WAGES 

To derive them by assuming one or both of 
the remaining quantities, and then to turn 
about and use them in accounting for the 
latter, would obviously be reasoning in a circle. 

None of the theories so far examined has 
explained, or appears to be justified in assuming 
as accounted for, more than one quantity. 
That quantity is I', the gross income, if taken 
in the sense of the product in the shape of 
consumable goods of a completed process of 
production. Its amount is explained by refer- 
ence to the technical conditions of production 
and its value by the demand of the market. 
If, however, V is to include the product of 
different stages of the process of production, 
— intermediate or producers' goods, as well 
as consumers' goods, — it cannot be accounted 
for without bringing in one of the remaining 
three quantities. 

The productivity theory aims to explain R 
by showing the relation between C and either 
I or I'. It must, therefore, account for the 
value of C, and at that point, as critics have 
shown, the theory breaks down. 

The time-preference and abstinence theories 
seek the origin of R in subjective conditions. 
If successful in this, they would not need C 
or I to account for R but could, on the contrary, 
derive C and I from the R which they have 
explained, and the V which they might legiti- 
mately assume as known. If, however, the 
criticism of these theories presented in Chapters 



THE ESSENTIALS OF A THEORY loi 

III and IV are at all valid, the attempt to 
derive R from subjective factors has proved a 
failure. The time-preference view is false to 
the psychology of investment and the abstinence 
theory, while suggesting subjective factors which 
may have some influence on investment, fails 
to prove that such factors give a definite quan- 
titative result, or in other words, that they 
make R just what it is. 

If we take any process of production from 
beginning to end, l\ its product in the shape 
of consumers' goods, may be assumed as known 
and accounted for. One other quantity must 
be found. This can not be R. The productivity 
theory makes no effort to show an independent 
origin of R; the time-preference and abstinence 
theories have failed in that attempt. It must 
therefore be I or C. No way has yet been 
suggested of accounting for I without using 
either C or R. The theory of interest must 
therefore seek to show the quantitative deter- 
mination of C. No other course appears to 
be left open. 

With C determined as well as F, the minimum 
of data needed to account for the rate of profit 
and interest is given. But C must be deter- 
mined independently of I and R. Furthermore, 
as there appears to be no way of deriving C 
from F except by a not permissible introduction 
of either R or I, we may say that it is a necessity 
of theory to account for C without resort to 
I'. Capital (C) as quantitatively determined 



I02 PROFIT AND WAGES 

must be accounted for independently of the 
other three quantities with which the theory 
of interest and profit has to reckon. 

What is this capital (C)? If we view the 
production of any kind of consumable goods 
as a whole and disregard its segmentation into 
particular industries, we see that what entre- 
preneurs and capitalists as a class invest, is 
just wages, nothing more. If wages as C can 
be shown to be determined independently of 
the gross income (F) of industry, then I, the 
net return to capital, can be obtained by sub- 
traction from gross income, and R is easily 

reckoned by the formula pr • The theory of in- 
terest as we have seen is driven to account for 
C independently of the product of industry I' 
and the rate of interest or profit (R) . If capital 
is restricted to so-called "capital goods" this 
is impossible. The value of a machine, for 
instance, as has been shown, cannot be obtained 
without assuming a rate of profit and interest. 
Nor will the money invested serve the purposes 
of theory. It is not money, but what can be 
bought with it that is the source of income. 
The only way to get an independently deter- 
mined investment upon which the return ob- 
tained can be calculated as a rate, is to view 
the process of production as a whole. Then it 
will appear that the investment made by entre- 



THE ESSENTIALS OF A THEORY 103 

preneurs and capitalists is all in the form of 
wages. C, therefore, consists of the total of 
wages. 

If the above conclusion in regard to the 
direction in which we must seek for a solution 
of the problem of the amount and rate of 
income on capital is correct, it will be necessary 
to find an explanation of wages apart from the 
size of the product of the productive process 
(!') or the prevailing rate of capitalist return (R). 
That, however, brings us into conflict with the 
productivity theory of wages, which in one 
form or other, commands the adherence of 
most economists. 

Now the theory of a specific product of labor, 
separable from the specific product of capital, 
and determining wages, we have already dis- 
posed of by implication in our criticism of the 
specific productivity theory of interest. It 
is in obvious conflict with the fact that the 
employer regards the sums paid out in wages 
as capital on which he must earn interest, at 
least. He could not afford to pay more than 
the discounted value of the product to the 
laborer. The widely accepted theory of wages 
as determined by the discounted marginal 
product, however, stands in a much stronger 
position. A detailed criticism of it will be 
given in Chapter VIII. This form of the 
productivity theory has the advantage of not 
being out of harmony with the conception of 
the productive process gained when it is viewed 



I04 PROFIT AND WAGES 

as a whole. When this view is taken it appears 
very clearly that we are driven to a choice 
between two theories of residual income.* One 
theory would hold the rate of profit to be 
determined by subjective factors, by calcula- 
tions of the cost of abstinence or waiting. In 
that case the wage-earner, receiving the product 
of labor discounted, is the residual claimant. 
The other would find an independent explana- 
tion of wages, in which case profit of capital 
can be accounted for as residual income. The 
former alternative is not open to us if our 
criticism of the time-preference and abstinence 
theories is valid. There remains, therefore, 
only the residual claimant theory of profit. 

The details of a theory of wages on which 
this view of profits can be based will be developed 
in the two following chapters. The remainder 
of this chapter will be given to an exposition 
of the theory of profits we have reached on the 
assumption that the theory of wages necessary 
to it can be demonstrated. Anticipating a 
little, however, we may state that the explana- 
tion of wages to be given is based, in part, on 
the idea of a supply price of labor determined 
chiefly by conditions outside of capitalistic 
industries and localities. The gains of capital 
are largely a result of the productive superiority 

*Unless with the "bargain theory" of wages, we practically 
give up the attempt to account for the existing division of 
the marginal product between capital and labor, and declare 
it to be simply the somewhat indeterminate outcome of a 
struggle. 



THE ESSENTIALS OF A THEORY 105 

of the capitalistic method. By using expensive, 
"roundabout" processes and methods of utiUzing 
natural forces, not accessible to the laborer 
because of his ignorance and poverty; by 
organizing, disciplining, and driving laborers 
to greater effort than they will or can put forth 
when working by and for themselves, — capit- 
alistic industry produces a surplus, a value in 
excess of what is paid out in wages. The wages 
paid constitute the capital invested, if we 
regard industry as a whole. The surplus 
product is profit of capital plus land rent. 
Setting aside rent and differential profit as the 
excess income of investments receiving more 
than the marginal return, this surplus, as profit 
of capital, can be stated as a percent ual rate 
of the sum paid out of wages. How this rate 
is divided between capitalist and entrepreneur, 
establishing a rate of interest, as distinct from 
this rate of profit, we need not consider at 
present. It is not a problem that presents 
insuperable difficulties.* The crucial problem 
is the rate of profit. 

This theory of profit makes the productive 
advantage of the capitalistic process appear 
as an important source of profit and interest, 
yet cannot properly be called a productivity 
theory. The surplus of product left after wages 
are paid, which constitutes profit, while largely 

*A very satisfactory account of how the rate of interest is 
established can be found in Hadley's Economics, p. 269 ff. 



io6 PROFIT AND WAGES 

due to the technological advantage of using 
capital, can in part be traced to other sources. 
Some of it is due to the knowledge and energy 
of those organizing industry. Some also to 
all those forces, whether operating within or 
without the sphere of capitalism, which make a 
cheap supply of labor by keeping down the 
standard of living and narrowing the economic 
opportunities of non-capitalistic labor.* Nor 
does it follow that the entire technological 
advantage will go to capitalist and entrepreneur, 
and that the laborer may never have a share 
in it. Some of the surplus may be used to lure 
labor into the capitalistic system. Some may 
go to labor when a strong union, seizing a 
temporary advantage, drives a hard bargain. 
Some goes to skilled labor which has been 
reared within capitalistic districts and which 
outside of capitalistic industries could look for 
no return whatever. 

The title of productivity theory would not 
fit the views here set forth. Nor would the 
term exploitation theory be any more appro- 
priate, although it is suggested that interest 
grows out of a portion of the product of labor 
withheld from the laborer. The term exploita- 
tion carries an ethical connotation which it 
would have been well to keep out of economic 

*Loria and Oppenheimer have especially emphasized conditions 
of land ownership as a source of capitalistic gain. See a good 
'summary of Loria's writings by Rabbeno in Political Science 
Quarterly, Vol. VII. Of Oppenheimer's writings, see especially 
his Theorie der reinen und politischen Okonomie. 



THE ESSENTIALS OF A THEORY 107 

theory. Whether there is the moral wrong of 
exploitation at the source of capitalistic income 
is a question outside of the scope of economic 
investigation. It is not probable that the 
purely economic theory of distribution can 
contribute more than a small part of the data 
necessary to a judgment upon the present 
social system as a whole, and of the ethical 
status of the income of capital in particular. 
We are taking a small and inadequate view of 
the problem raised by socialism, if hopes or 
fears of settling that problem give any bias 
to our thought in the study of the theory of 
interest and profit. 

It is desirable, therefore, if a name must be 
given to the theory here set forth, to find a 
term without ethical flavor. Such a safe, 
colorless term, one properly applicable, is that 
of residual-claimant theory. It is the name 
which has been given to the theory of profit on 
capital of Ricardo and Marx, with which our 
theory is in substantial agreement.* 

At this point it will be desirable to consider 
briefly three questions suggestive of objections 
to the theory here advanced, (i) What is 
there to prevent excess product due to capital 

*See Hollander (The Residual Claimant Theory of Distribution 
in Quarterly Journal of Economics, February, 1903) who applies 
the name to the theory of Ricardo. In the third of an interest- 
ing series of articles on "Wertrechnung und Preisrechnung im 
Marxschen System," in the Archiv fiir Sozialwissenschaft 1907, 
Bortkiewicz suggests the name Abzugstheorie for the theory 
of Ricardo and Marx. 



io8 PROFIT AND WAGES 

from bringing about a fall of values which would 
extinguish profit and interest? (2) What keeps 
labor from demanding and obtaining all that it 
produces? (3) How is the surplus value grow- 
ing out of a series of processes, under the control 
of different entrepreneurs, distributed as a 
fairly uniform rate to every part of the invest- 
ment made by each entrepreneur, and not 
alone to the sums paid out as wages? 

To take up the first question: why does not 
the surplus value including profit and interest 
disappear in a fall of prices? How can the 
profit be kept from the "consumer?" There 
is here suggested the objection sometimes made 
to the productivity theory of interest, that it 
does not show how the capitalist can keep his 
"product of capital" from lowering prices till 
interest disappears. This apparent difficulty 
is by some writers made the occasion for bringing 
in the cost of abstinence as a necessary check 
upon redundancy of capital and capitalistic 
production. The objectors, however, fall into 
the common error of thinking of but one industry 
at a time. Excess of product in one industry 
might indeed bring about a "ruinous" fall in 
value. A general fall of values, however, is 
impossible. 

Moreover the objection that profit and interest 
will be surrendered to the "consumer" unless 
production is in some way limited, rests on an 
erroneous conception of the status of the con- 
sumer. When we look at things, not from the 



THE ESSENTIALS OF A THEORY 109 

point of view of a single industry, but of the 
industrial system as a whole, it is obvious that 
the "consumers," the purchasing public, are 
not a class distinct from the "producers," nor 
an independent factor governing prices. The 
purchasers or consumers are the capitalists 
and laborers of the productive process. As 
long as the laborers do not receive the whole 
sum of money and credit possessed by capitalist 
and entrepreneur, as long as the latter retain 
something for themselves, this something, added 
to the purchasing power in the hands of the 
laboring class, will keep the total of prices of 
commodities above the total paid out as wages. 
The sum of prices cannot extinguish profit of 
capital by falling to the sum of the outlays for 
wages. As long as the capitalist and employer 
are not obliged to surrender everything to the 
employe, profit and interest will continue. 

But may profit of capital throughout industry 
as a whole be made to disappear by a rise of 
wages? This is the second objection our theory 
must meet. Why does not labor obtain the 
entire product? As long as the value of the 
product is in excess of the wages paid, would 
it not be profitable to employ additional labor? 
Would not this be kept up until in every industry 
wages equalled the marginal product leaving 
only a differential profit on the more productive 
investment but no profit or interest at the 
margin. The adherents of the abstinence or 
time-preference theories would assert that the 



no PROFIT AND WAGES 

needs of the marginal saver, the cost of his 
abstinence or waiting, or the degree of his 
reluctance to give up present for future goods, 
would check the upward course of wages. 
Do these subjective factors act as a check on 
any forces tending to narrow the rate of profit? 
And if they do not, what is there to save capit- 
alist income from extinction? In Chapter IV 
it has been shown how doubtful and uncertain 
is the influence of subjective factors in checking 
the fall of profit. It was also shown, however, 
that, when additional supplies of capital meet 
a vanishing rate of return, either forces destruc- 
tive of redundant capital are brought into 
action, or new opportunities are somehow found 
for profitable exploitation. Does an increasing 
supply of capital have a tendency to raise 
wages? Whether it does or not, there are 
forces sufficient to check an increase of capital 
leading up to an extinction of profit, — forces 
so erratic in their operation, however, that 
it is impossible to predict their course by any 
simple formula. But the factors determining 
the scale of wages form the subject matter 
of the two chapters following this. A full 
discussion of whether they could threaten profit 
with extinction would be out of place at this 
point. 

The third difficulty which must be met by 
the theory here advanced is that suggested by 
the question as to how the surplus product 
growing out of a series of processes under the 



THE ESSENTIALS OF A THEORY iir 

control of different entrepreneurs, is distributed 
as a fairly uniform rate and assigned to each 
entrepreneur's investment and, moreover, to 
every part of it and not alone to the sum paid 
out as wages. Apparently a rate can be cal- 
culated only by the summation of the incomes 
of all the capitalists and entrepreneurs and the 
estimation of this sum as a percentage of the 
total paid out as wages. But how is one to 
proceed from this rate to a rate assigned to 
every part of the investment, to machinery and 
buildings, as well as to the sums paid as wages? 
As a matter of fact, the rate of total profit is 
purely theoretical. The gain to capital which 
arises as a surplus of total product over the 
total of wages is a quantity not estimated by 
any one as a percentual rate. It is a quantity, 
however, for which entrepreneurs engage in a 
struggle and out of this struggle arises an average 
rate of profit which coincides with the theoretical 
rate of total profit. 

If the entire process of making any given 
commodity, including the production of all 
material and investments entering into the 
product, or used up in the process, were con- 
trolled by one entrepreneur, — whether an indi- 
vidual, a partnership, or a corporation, — it 
would be possible to state total returns above 
wages as a percentual rate upon wages regarded 
as the investment. Actually the process is 
divided up among different entrepreneurs, and 
among these the return in excess of wages, is 



112 PROFIT AND WAGES 

divided roughly according to the extent of 
their investment. If the entrepreneurs of the 
earUer stages of the process of production seek 
unusual gains at the expense of those in the 
later stages, the latter can threaten to make 
themselves independent of the former by under- 
taking to produce for themselves the materials 
and instnunents they may need. Or they 
can encourage competitors of a more reasonable 
frame of mind. In like manner the entrepreneurs 
of the earlier stages can defend themselves 
against those of the later. Thus, through 
bargaining and competition, a rate of profit 
becomes established for any given industry. 
By movements of capital from one industry 
to another, the rate is equalized throughout 
the industrial system.* This equalized or 
average rate of profit is, of course, only a 
theoretical approximation to actual conditions, 
a static goal never fully attained in this dynamic 
world. The sums invested are given a share 
in the returns according to the time at which 
they enter the investment. In other words, 
the rate assigned makes allowance for the time 
element, and is calculated and compounded 
according to a custom established before modem 
capitalism itself. 

The solution of the problem of profit of capital 
and interest given above, assimies the existence 
of interest and capitalistic calculation. What 

*Compare Ricardo, Principles, Chapter IV, and Marx, Kapital, 
Vol. Ill, especially Chapter X. 



THE ESSENTIALS OF A THEORY 113 

the historical origin of interest may have been, 
how such an income was possible before the 
modem machinery of production, and why it 
was estimated and compounded at a time rate, 
are questions we need not seek to answer. 
The theory aimed at in all of the foregoing 
discussions, applies to the modern era alone and 
may, therefore, assume as given such factors 
as have been transmitted from pre-capitalistic 
times. As long as the method of "theory" 
takes its premises from conditions now open 
to observation and not from the historical past, 
it must, of necessity, submit to such limitations. 
It reveals the forces at work in the present and 
the conditions of their continuance. It can 
make no pretense of throwing light on the 
whole course of the evolution of economic 
institutions whose birth has preceded our his- 
torical era. 



CHAPTER VII 

THE THEORY OF WAGES. THE SUPPLY OF LABOR. 

Our discussion of the income of capital has 
led of necessity to the question as to what 
determines wages. The marginal product of 
industry is divided between profit and wages. 
A theory of either of these shares carries, by 
implication at least, a definite opinion in regard 
to the determinants of the other. The view of 
profit and interest as residual, set forth in the 
preceding chapter, rests distinctly on the assump- 
tion that wages are determined independently 
of the rate of profit and of the value of the 
product. Obviously the next step in our argu- 
ment must be to establish a theory of wages in 
harmony with this assumption. Such a theory, 
however, is not likely to meet a very ready 
acceptance unless the, at present widely held, 
productivity theory of wages can be dislodged. 
A criticism of this theory will be offered in the 
next chapter. In passing, however, it should 
be pointed out that because of the close relation 
between profit and wages, our criticism of certain 
theories of interest, if valid, has by implication 
given a refutation of the productivity theory 
of wages associated with these theories. If, 
for instance, there is no specific product imput- 
able to capital, separable from the specific 
product of labor, then there is no specific product 



THE SUPPLY OF LABOR 115 

of labor. Thus the weakness of the specific 
productivity theory of interest is also the weak- 
ness of the specific productivity theory of wages. 
Moreover, the impossibility of regarding em- 
ployers as willing to pay out sums of money 
for wages upon which they do not earn interest 
at least; in other words, to pay the full undis- 
counted product of labor to the laborer, — 
makes the specific productivity theory appear 
too obviously inadequate to deserve much 
attention. 

A theory much in fashion to-day, is that of 
wages determined by the discounted marginal 
product, the rate of discount being fixed by the 
"rate of time-preference" or the "cost of wait- 
ing." But, if we have succeeded in our attempt 
to show that time-preference or calculation of 
the cost of waiting, or postponement, or absti- 
nence, or any subjective valuations by whatever 
name, can create no definite rate of discount, 
then obviously wages cannot be explained as 
determined by discounting the product. 

In the view of profit of capital as a residual 
claimant set forth by Ricardo and others, the 
underlying theory is that of wages determined 
by the cost of subsistence of the laborer. If 
this theory of wages were acceptable, our 
argument would have brought us to the Ri- 
cardian view of distribution in most of its 
essential positions. Another basis for a theory 
of profit as residual, might possibly be found 
in the bargain theory of wages, the theory 



ii6 PROFIT AND WAGES 

that wages are the outcome of a contest, of 
Machtverh'dltnisse. A discussion of these two 
theories must be undertaken, but also of those 
in obvious conflict with the theory of profit 
and interest for which we are contending. 
Following the course of historical evolution let 
us begin with an examination of the subsistence 
theory. 

The argument for this theory was based on 
Malthusian views in regard to the growth of 
population. If wages rose above the "natural 
wage," earlier marriages and a higher birth 
rate increased the supply of laborers and 
reduced wages to the old level. If wages fell 
below the natural wage, postponement of mar- 
riage and a lowered birth rate, diminishing the 
supply of labor, raised wages again.* 

But how much was the "natural wage?" 
It was supposed to give the laborer a living 
according to the customary standard of his 
class. How this "standard of living" originated, 
the classical economists did not inquire. It 
was an historical problem which they were 
under no necessity of solving. All that was 
essential to their argument was that the standard 
should be stable. This implied that in times of 
falling wages, the standard would not be sac- 
rificed to the desire for marriage; but that in 
times of rising wages, marriage would be the 

*A minor factor was the death rate varying inversely with 
changes in wages. It makes no difference to the argument 
to omit its action from consideration. 



THE SUPPLY OF LABOR 117 

first claimant on the increased income. It 
supposed a great fixity in the manner of hving 
of the working classes in everything except the 
age of getting married and the consequent 
eventual size of the family. 

Now if the term "natural wage" was to have 
a definite meaning, it was that of a wage suf- 
ficient to maintain at the customary standard 
a family of a given average size* As actual 
wages departed from the natural wage, the 
standard of comfort was maintained by a varia- 
tion in the average size of the working class 
family. Thus except in short periods of transi- 
tion and adjustment, actual wages would always 
cover the standard of living. This correspond- 
ence between wages and the standard of living 
could not, however, be regarded as evidence 
that the standard effectively determined actual 
wages. Unless one considered results in the 
long run, the truer view would be that wages 
on the one hand, determined primarily by 
"demand," and the standard of living on the 
other, had no effect on each other, but together 
determined the average size of workingmen's 
families. To express the same thought in 
a different manner, the standard of living 
maintained itself in the face of fluctuating 
wages by varying the average size of families. 
If, however, one looked at the tendencies of 
a long run, it would appear that these changes 

*To be very precise, a given average size and composition, as 
expenses would vary somewhat according to age and sex. 



ii8 PROFIT AND WAGES 

in the average size of the family would eventually 
affect the supply of labor and thus influence 
the level of wages. 

It should be noted, however, that the factor 
set forth by the classical writers as regulating 
the supply of labor was obviously extremely 
slow in its action. It might take fifteen to 
twenty years for a sufficient number of children 
to be born and trained to industrial pursuits, 
to increase effectively the supply of labor; or 
before the death rate overtaking a diminished 
birth rate could effectively decrease the supply. 
Because of this slowness, the regulation of the 
supply through the growth or decline of the 
laboring population would bring wages back 
to the "natural wage," only if disturbances 
of the actual or "market" wage through fluctua- 
tions on the side of "demand" did not occur 
except at long intervals. 

But is there a natural wage? Ricardo defined 
it as the amount necessary to enable laborers 
"to subsist and perpetuate their race, without 
either increase or diminution." Now the en- 
tirely stationary wage-earning population sup- 
posed by Ricardo, in all probability, never 
existed. And if population has always either 
increased or decreased, "natural" wages were 
never paid. The concept of natural wages, 
therefore, could at best serve as a means of 
exposition only, indicating an ideal point of 
equilibrium towards which the forces making 
the rate of wages were supposed to be working. 



THE SUPPLY OF LABOR 119 

The slow operation of the factors set forth 
by the Mahhusian argument for the subsistence 
theory, forms the basis of Marx's criticism of 
this argument. Holding that there is a decennial 
cycle of prosperity and crisis, he reasons that 
long before a rise or fall of wages could have 
any effect on population the whole scene would 
be shifted by various phases of the business 
cycle.* As an objection to the notion that a 
given natural wage could be brought about 
primarily by the movements of population, 
Marx's argument has great force. It does not, 
however, dispose of the fact that the size of 
the working population has an effect on wages. 
Indeed, the further development of Marx's 
own ideas on wages implies such an effect. 
Nor does Marx prove that wage fluctuations 
are of such disconcerting frequency that the 
movement of population cannot at all be affected 
by a rise or fall of wages. 

An objection to the Malthusian argument 
for the theory analogous to that presented by 
Marx, is suggested by the part which immigra- 
tion plays today in almost all the great industrial 
districts of the world. Against the vast tide 
of immigrants, the slow changes caused by 
fluctuations in the native birth rate seem of 
very slight significance. It should be remarked, 

*Das Kapital, Chapter 23, Section 3. 



I20 PROFIT AND WAGES 

however, that at the time the subsistence 
theory gained its position in orthodox poHtical 
economy, this difficulty did not exist. 

In view of the slowness of the factors described 
in the classical exposition of the subsistence 
theory, there was obviously the need of a 
theory of wages in which the supply of labor 
should be regarded as practically fixed for the 
time being — a theory of actual, or "market 
wages," as distinct from the "natural wages" 
towards which things tended vaguely in the 
long run. In such a theory the emphasis would 
necessarily be on "demand" for labor. That 
the subsistence theory was not a complete 
explanation of the rate of wages was clearly 
recognized by its classical exponents. They 
supplemented it with the wages-fund theory 
in which the emphasis was placed on the factor 
of demand, and which aimed to explain market 
wages. Thus two theories were held simul- 
taneously. In one, the wages fund theory, 
the supply of labor was regarded as fixed for 
the time being. The other, the subsistence 
theory, we have seen could account for existing 
wages, only on the assumption that changes in 
demand occurred at long intervals only, or 
in other words, that the factor of demand was 
fixed for long periods of time. 

Now it might appear from the trend of our 
discussion up to this point, that our chief con- 
cern must be a theory of "market wages" and 
of the factor of demand. Though recognizing 



THE SUPPLY OF LABOR 121 

that anything affecting the birth rate would 
ultimately influence the supply of labor, and 
therefore, affect wages, it might appear that 
we are forced to consider such influences so 
slow in their operation and so disturbed by 
various factors of more rapid movement, that 
all attempts to embody them in a general 
formulation of a wage theory should be given 
up. Why not rest satisfied with a theory based 
on the assumption of population as fixed for 
the time being? It will appear, however, in 
the further progress of our analysis, that we 
need not give up trying to make some definite 
statement in regard to the factor of the supply 
of labor. Indeed, there is something like a 
definite supply price of labor, as important in 
its influence on wages as anything on the side 
of demand. 

But let us return to the subsistence theory. 
The greatest obstacle to its continued and 
unquestioned acceptance appeared when it was 
seen that the standard of living of a large part 
of the industrial population was rising. If 
wages had gone downward instead of upward, 
the standard might have exhibited greater 
fixity. As it was, the idea began to gain ground 
that the standard of living was too unstable 
to be regarded as a regulator of wages. The 
concept of a natural wage vanished into thin 
air. Even the more modem idea of supply 
prices for different quantities of labor, the idea 
of wages acting as inducement for an increased 



122 PROFIT AND WAGES 

or decreased supply of labor as they rose or 
fell, became untenable. If, for instance, a 
rise of wages carried the standard of comfort 
upward, its ultimate effect might be, by lowering 
the birth rate, to decrease rather than to 
increase the working population. It did not 
appear, however, that the standard is so in- 
stantly and extremely variable that there is 
no standard at all. For the time being there 
is a standard, though possibly a short-lived one. 
In the interval before the change to a different 
level, the standard has some effect on the birth 
rate and, therefore, ultimately on the supply of 
labor and its price. But if it affects wages it 
is also affected by them. The definite, non- 
reciprocal action on wages assigned to it by the 
classical school is not perceptible. 

But though the subsistence theory of wages, 
based on the Malthusian argument, became 
involved in all these difficulties, it does not 
follow that it was never, at any place, a valid 
explanation of the facts. Within certain geo- 
graphical and historical limits, some of its 
reasoning may be applicable. On the back- 
ground of modem capitalism, to be sure, with 
its large fiuctuations of employment, its pressing 
host of immigrants, and the instability of all 
standards of comfort and discomfort, the Ricard- 
ian doctrine of a natural wage looks like some 
pale, ancestral shade. But it was from a different 
world that Malthus gathered the evidence for 
the "principle of population" which was made 



THE SUPPLY OF LABOR 123 

the basis of the theory of natural wages. For 
most of the people of the eighteenth century 
there was still the regular routine of agricultural 
pursuits calling for almost the same number of 
workers year after year. There was little 
immigrant labor and the manner of living, 
consecrated by custom, was almost incapable 
of variation. In the backward, rural districts 
of the old world from which today we derive 
our supply of unskilled laborers, we may still 
see conditions differing but little from those 
pictured by Malthus. To be sure the portentous 
fact of emigration has broken into the quiet 
current of their life. The established standard 
of living, however, still possesses stability. 
A temporary fall of income results in emigration 
and postponement of marriages, a rise, in 
earlier marriages and a higher birth rate. 
New commodities enter but slowly into cus- 
tomary use. The luxuries and novelties of the 
well-to-do are both geographically and socially 
too remote to lure to a more expensive scale 
of living. Of course, the subsistence theory 
may not be applied without qualification to 
an explanation of the income of the laboring 
population of these non-capitalistic regions. 
As already indicated, the theory cannot, in any 
case, offer a complete explanation of the level 
of wages. If, however, we had only these old 
world conditions to consider, the classical 



124 PROFIT AND WAGES 

doctrine of wages adjusted to cost of subsistence 
might be allowed as a rough approximation 
of the actual forces at work. 

It may be asked, what is the need of any 
reference to old world conditions? Our con- 
cern is with the dividing up of the product of 
capitalistic industry and, therefore, with the 
wage level of modern industrial centres only. 
The reply to be given is that it is a mistake 
to fix the attention exclusively upon the indus- 
trial areas or to think of economic life as all 
within an isolated, national unit. The con- 
ditions of the distant sources of our labor 
supply cannot be without influence upon indus- 
trial wages. We may be sure that an important 
factor determining wages in all growing indus- 
trial centres is found in the terms upon which 
additional laborers can be secured. But securing 
additional laborers means attracting increased 
immigration. The average income of the old 
world population from which our unskilled 
laborers are almost entirely drawn may be 
said, therefore, to constitute part of the supply 
price of labor for our industries. That much, 
at least, must be paid — and in order to induce 
men to immigrate — something more. We may 
leave open the question as to whether this 
income determined by pre-capitalistic conditions, 
is best explained by emphasizing the customary 
standard of living, or the narrow productive 
opportunities of these workers. For us the 
significant fact is that this income plus an 



THE SUPPLY OF LABOR 125 

amount sufficient to act as inducement to 
emigrate to the regions of modern industry, 
is the price which must be paid to secure the 
lower grades of labor for our industries. 

For the higher grades there enter other factors, 
less easily summarized in general formulse. 
Often it will be necessary to regard the supply 
of certain kinds of skilled labor as practically 
fixed. So far as it is possible to make out a 
"supply price" for an additional amount of 
one of the higher grades, it equals the wages 
of unskilled labor, — determined, as we have 
seen, in large part by non-capitalistic condi- 
tions, — with enough in addition to induce 
part of the working population to undergo the 
necessary training, or to bear the expense of 
educating their children, towards a more spec- 
ialized or more intelligent type. 

The price of unskilled labor, therefore, is 
fundamental to the determination of the wages 
of all grades of employment. From the point 
of view of capitalistic industry it is cost rather 
than utility that makes the supply price of 
labor. In other words, the average income set 
by conditions outside of capitalistic industry 
enters as an independent factor into the deter- 
mination of wages paid in capitalistic industries. 

If the views set forth above are correct, we 
may speak of a fairly definite supply price for 
labor. It varies both with the grade of labor and 
with locality. At the distant sources of our 



126 PROFIT AND WAGES 

immigrant labor, in the backward, rural dis- 
tricts of the old world, a fairly stable standard 
of living makes a rise or fall of wages result 
respectively in an increase or decrease in the 
rate of growth of the population. Such adjust- 
ments of the supply of labor, however, are 
slow and imperfect. For the areas of capital- 
istic enterprise, the important factor deter- 
mining supply of labor is immigration. More 
or less of immigrant labor can be attracted as 
wages are raised or lowered. 

An important part of the supply price con- 
sists of the amount necessary to act as induce- 
ment to undergo the expense and hardship of 
immigration. The supply price of labor will, 
therefore, tend to vary directly with the distance 
from the sources of immigrant labor and with 
the perfection of means of communication. 
It is often assumed that wide geographical 
differences in the remuneration of labor are 
due to corresponding differences in produc- 
tivity.* The views just set forth suggest a 
different explanation of the undoubted fact 
that where wages are high, the productivity 
of labor is likely to be high. Where, for geo- 
graphical reasons, the supply price of labor 
is high, only the most productive uses of labor 
are profitable to the employer. Where, on the 
other hand, the supply price is low, the appli- 
cation of successive "doses" of labor may be 

*For instance, in discussions of the influence of protective tariffs. 



THE SUPPLY OF LABOR 127 

carried further down the scale of diminishing 
returns, to a lower margin of productivity. 

These propositions in regard to the supply 
price of labor do not, of course, give a complete 
explanation of the wage level. An examination 
of the forces making what is called "demand 
for labor" must be the next step in our analysis. 



CHAPTER VIII 

THE THEORY OF WAGES. THE DEMAND FOR LABOR 

The subsistence theory emphasized factors 
affecting the supply of labor, but implied the 
action of both demand and supply as deter- 
minants of the price of labor. It was avowedly 
only a theory of what wages tended to be in 
the long run. The wages fund theory of the 
classical economists gave an explanation of 
what constituted the total demand for labor, 
but fitted this into a theory of temporary 
"market wages" only. There was no reference 
to what made demand in the long run, but 
obviously this was determined by the accumu- 
lation of capital. The relation between total 
demand for labor and the total working popu- 
lation determined wages for each season of 
employment, but in the long run these "market 
wages" or actual scales of payment tended 
towards the "natural wage." 

The wages fund doctrine is an example of 
the bold collective conceptions of the classical 
school. Brushing aside the factors entering 
into all the diverse, particular wage contracts, 
it gave a view of the wage level as a whole, as 
though capitalists united as a class dealt with 
labor as a class. It rested on the thought that 
so viewed capitalists and laborers are forced 
to make an exchange with each other; that 



THE DEMAND FOR LABOR 129 

each party brings just one commodity to this 
trade, the capitaHsts their capital, the laborers 
their labor power, and that each party is 
obliged to give its entire commodity in exchange 
for that of the other. 

In a rough way these views are true — as 
true, perhaps, as any general theory in this 
field ever can be. That the laborers have to 
sell their commodity on pain of starvation is 
obvious. To be sure, some of them might 
emigrate, and the supply of labor might be 
varied a little by a greater or less number 
acting as their own employers in agriculture, 
or as handicraftsmen, or petty shopkeepers. 
This, however, does not substantially qualify 
the fact that the larger part of the quantum of 
labor-power existing at the time being has no 
"reservation price," that it has to be sold no 
matter how low the scale of payment.* That 
despite this cruel necessity not all labor power 
is sold and that some deteriorates and becomes 
unsaleable, are qualifications which may fairly 
be omitted from a general statement of 
tendencies. 

*It must be remembered that at this point we are considering 
a theory of the forces of the moment only, those making 
"market wages." In the long run, of course, the classical 
economists held that cost of subsistence was a reservation 
price for labor. It may be remarked that they gave no thought 
to the fact that with a fixed number of laborers employed, 
there may still be an increase or decrease in average perfor- 
mance, and that efficiency may, therefore, be said to have its 
reservation price. However, we may assume a standard of 
efficiency for the time being, not susceptible of rapid change, 
and, therefore, not giving occasion for much qualification of 
the statements made above. 



130 PROFIT AND WAGES 

A similar necessity of coming to terms rests 
on the class of capitalists. They must seek 
to invest all of their capital as long as there 
is a prospect of gain. They will not succeed 
at once in investing all, just as some labor- 
power fails to find an immediate market. But 
in order to indicate general tendencies, we are 
justified in assuming that all of the labor-power 
and all of the capital are disposed of. The efforts 
of capitalist and laborer to sell or invest all 
they have to sell or invest, whether entirely 
successful or not, make the rates of remuneration 
what they are. The wages fund theory, like 
other economic theories, only indicates the 
point of equilibrium toward which economic 
forces are working. It deals with the statics 
of the problem of wages. Friction and "dy- 
namic" changes in the factors assumed may 
bring it about that the point is never actually 
reached. We have in consequence to rest 
satisfied with a formulation of tendencies only. 

But if capitalists succeed in investing all 
of their capital, does that mean that it all 
goes to pay wages? Must all investment be 
regarded as fundamentally an exchange between 
capitalist and laborer? May not the capitalist 
employer use part of his funds to buy "capital 
goods" — machines, for instance, — instead of 
hiring labor? Such objections, of course, occur 
readily to those who either differentiate wages 
funds entirely from capital or regard them as 
only part of capital. If it is permissible to look 



THE DEMAND FOR LABOR 131 

at the problem of wages from the point of 
view of an individual business or segment of 
the long productive process, the wages fund 
doctrine, of course, appears absurd. But the 
wages fund theory is not one of particular 
wages, or wages in particular industries, but 
an attempt to explain the general wage level. 
It might appear, therefore, that the investment 
of the class of capitalists as a whole only should 
be taken into consideration. In that case what 
one capitalist gives to another, the price paid 
for a machine, for instance, should be eliminated 
from consideration. Only that is invested and 
a source of gain for the capitalist class as a 
whole, and, therefore, to be regarded as capital, 
which goes to other classes. Disregarding 
advance payments of rent, only that which goes 
to the laborers, i. e., the wages fund is capital. 
According as it distributed over a large or a 
small number of laborers, it makes a low or 
high average of payment. Its division between 
different groups and grades of labor may 
change. Buying machines for an industry, for 
instance, may mean diminishing the number 
of workers employed and total wages paid in 
that particular industry while increasing the 
employment and wages of men engaged in 
making machines. 

Such is the view of the effect of buying 
additional machinery suggested by the concept 
of capital for which we have contended. But 
the matter is not quite so simple. It is begging 



132 PROFIT AND WAGES 

the question to rule out from consideration 
business outlays other than those for wages, 
by appealing to a definition of capital which 
expressly excludes such outlays. The fact 
that the wages fund alone is a source of gain 
to capitalists as a class, makes it legitimate 
in a general theory of distribution, to restrict 
the term capital to this fund. But the relevant 
question at this point is whether all of what men 
accumulate for investment and regard as ' 'cap- 
ital," ultimately reaches the laborer; or whether 
part of it may be paid to other parties, to the 
special group of capitalists who sell machines, 
for instance, and be consumed by them. The 
total funds accumulated for use in business 
must be invested. But must they all go to pay 
wages; or if not, is there a definite and fixed 
part of these investment funds destined exclu- 
sively for the payment of wages? 

When entrepreneurs substitute the purchase 
of machines for the hiring of labor, they appear 
to diminish the wages fund. But there must 
occur an increased employment of men in 
making machines. Does this mean that the 
point of application of the wages fund is shifted 
without change in the size of the fund itself? 
The prices paid for the machines cover the 
wages advanced, to those who had made them. 
If these prices included nothing else, that is 
if employers simply spent their capital for 
wages and, on the return of an equivalent from 
the sale of the products, reinvested this and 



THE DEMAND FOR LABOR 133 

again spent it all for wages, — if, in short, there 
were no interest and profit for the capitalist; 
then, indeed, all of the investment funds would 
have to go to the laborers, and the only question 
would be as to how the total is divided between 
different groups of workers. But the price of 
a machine includes profit and interest. Now 
if, in the language of Bohm-Bawerk, the average 
production period be lengthened, that is if 
more of the products of earlier labor be used 
in the later stages of the production of con- 
sumable goods, then there would be an increased 
outlay not only for labor at the earlier stages 
but also for profits and interest to the capitalists 
in charge of these stages. Part of what might 
have gone to the laborers at the later stages, 
is by this change of the production period 
converted into profits for a particular group of 
capitalists. Of course, coming to the latter 
as an increase of profit it would probably be 
invested at once and most of it used in paying 
wages. If, however, this increment of profit 
were consumed by its recipients, the total 
wages fund would be, to that extent, diminished. 
This might appear to qualify seriously the 
validity of the assumption necessary to the 
wages fund doctrine that there is a definite 
fund destined for nothing but the payment of 
wages. If, however, we consider the conditions 
under which such a contraction of the fund, 
as has just been suggested, could occur, it will 
appear that it is still allowable to make the 



134 PROFIT AND WAGES 

assiimption of a fairly definite wages fund. 
The outcome of such an extension of the pro- 
duction period, of the increased material equip- 
ment of the later stages, should be an increase 
of product and profit. What is paid as profits 
to the capitalists selling machines is an advance 
payment of their part in the increased profits 
of the longer productive process. The incre- 
ment of product of the longer process would, 
at first, fall into the hands of the employers, 
but a large part would be added to capital and 
pass into the hands of the laborer as wages. 
Thus only in the transition to a longer produc- 
tion period would there be a considerable 
deduction from the funds destined to be paid 
out as wages. 

Moreover the substitution of machines for 
men on a large scale would probably indicate 
the appearance of inventions of a revolutionary 
character. Such, of course, appear from time 
to time but should be regarded as dynamic in 
character. They may change some of the 
factors of the problem, such as the size of the 
investment fund and the proportion of it used 
in paying wages, and bring about a new resultant 
average wage. The theory we are considering, 
however, treats only of the static aspects of 
the problem of wages. To be sure, Bohm- 
Bawerk argues that apart from inventions, 
that is taking a static point of view, the average 
production period could be advantageously 
lengthened, if it were not for the lack of "cap- 



THE DEMAND FOR LABOR 135 

ital." His argument, however, rests on the 
assertion of the possibiHty of an indefinite 
increase of the rate of productivity with every 
extension of the production period, that is with 
every increase of material equipment to labor 
employed. This assertion has been shown in 
an earlier chapter to be an error.* In times 
of abundant capital it is likely, therefore, that 
the productively most advantageous proportion 
of equipment has been reached by all entre- 
preneurs except those doomed to fail. In other 
words, for every commodity there is a pro- 
duction period not likely to be greatly changed 
except by the dynamic factor of invention. 
When this has been reached, the wages fund 
may be regarded as a fairly definite proportion 
of the total funds for investment. 

It may be remarked in this connection that 
Bohm-Bawerk has set forth a theory of general 
wages which is virtually a wages fund theory, 
though he would not have it so regarded. It 
adds an element not developed in the classical 
doctrine by showing that a given fund may be 
used to hire labor for longer or shorter periods. 
Unless the length of the period is established, 
the average wage remains indeterminate. An 
increase of capital (of what Bohm-Bawerk 
calls the ''subsistence fund"), instead of giving 
a corresponding increase of wages to a fixed 
number of laborers, might be employed in part 
to lengthen the production period. The problem 

*See note page 24. 



136 PROFIT AND WAGES 

of the determination of wages, therefore, becomes 
that of showing how the efforts of the class of 
entrepreneurs to secure a maximum gain for 
themselves, establishes an equilibrium between 
three factors, — the given subsistence fund, 
the total number of laborers, and the length 
of the production period. In developing this 
idea, Bohm-Bawerk assumes that there is an 
unlimited possibility of increasing per capita 
product by lengthening the production period. 
As has been shown, however, there is a maximum 
of product attainable. If the supply of capital 
is such that the point of maximum productivity 
has been reached, the production period is fixed 
and the conditions assumed by the older wages 
fund doctrine prevail — that is, the wages 
fund and the number of laborers alone determine 
the level of wages. Under such static conditions 
an increased investment of capital cannot advan- 
tageously make a longer production period. 
It can only enlarge the total productive enter- 
prise by starting additional business units or 
enlarging existing ones. Even this is impossible 
unless the increase of capital is accompanied 
by an increased supply of labor. If the labor 
supply increases less rapidly than capital, a 
rise of the wage level must ensue. 

It is a necessary assumption of the wages 
fund theory that there is a fairly definite fund 
all of which will be used in the payment of 
wages. To state it more cautiously there will 
be an attempt to use all of it and that means 



THE DEMAND FOR LABOR 137 

paying it out in wages. And the attempt to 
use all of the fund is an important determinant 
of average wages. It would be fatal to the 
theory if it could be shown that the fund was 
capable of rapid contraction whenever the 
wage level was not altogether pleasing to 
capitalists. Of course, the possibility of erratic 
outside forces suddenly destroying capital or 
blocking its investment is not relevant. And 
from any point of view it must be assumed that 
the wages paid are less than the value of the 
product turned out. There must be some 
profit. But we should have to reject the theory 
if it could be shown that dissatisfaction with 
the general rate of profit resulted immediately 
in a contraction of the wages fund, or in other 
words, that capitalists would hold back from 
employment any considerable part of their 
wages fund while there was still any profit to 
be gained. 

Our discussion up to this point has been in 
defense of the wages fund theory and in support 
of its assumption of a fund not capable of 
rapid contraction. We have not, however, as 
yet examined some of the arguments which, 
when brought against it in the sixties and 
seventies of the last century, led to its sudden 
and all too complete abandonment. The critics 
of that time aimed to demonstrate a ready 
expansibility of the total of funds destined 
for the employment of labor. Little was said 
about a contractibility of the fund, though, 



138 PROFIT AND WAGES 

of course, that quality might be assumed as 
impHed in its expansibihty. The turn the 
discussion took was, no doubt, the result of 
the use which had been made of the theory by 
opponents of trade unionism. Could an organ- 
ized group of laborers get higher wages without 
a corresponding reduction of the remvineration 
of other workingmen, or was the total which 
might be paid to the laboring classes rigidly 
limited? That was the question upon which 
all arguraents tended to converge. 

Unfortunately the attacks upon the wages 
fund theory were based on a misconception, 
though a pardonable one, in view of the care- 
lessness with which the theory was usually 
formulated.* The fund was thought of as 
money, not as real income; the wages paid 
as money wages, not as real wages. Viewed 
thus it was readily seen that credit currency 
added an elastic element to the fund. Of 
course credit is somewhat limited by the quantity 
of cash underlying it. Beyond a certain point 
further expansion is impossible unless all con- 
siderations of safety are thrown to the wind. 
It would take us too far afield to consider all 
the conditions of credit expansion and con- 
traction. Only in so far as the wage level is 
concerned with such fluctuation is the matter 
at all relevant to our discussion. Other factors, 
such as speculation and political rumor, epi- 
demics of optimism or depression, perhaps 

*Taussig, Wages and Capital, Chapter XII. 



THE DEMAND FOR LABOR 139 

most of the forces determining the degree of 
credit expansion, must be regarded as dis- 
turbing outsiders by the theory of wages. 
The thought of these forces suggests how 
inadequately the confused and shifting reahty 
is described by general theory and should teach 
caution in the application of abstract doctrine 
to concrete problems. But if general theory 
is at all permissible, then the theorist is war- 
ranted in disregarding such disturbing factors 
and proceeding as if they did not exist. One 
of the traditional and necessary methods of 
economic theory is to disregard the existence 
of a fluctuating supply of money and credit, 
and to fasten the attention on real income only. 
Now what of the wages fund when thought 
of as real income, as a stock of subsistence or 
consumers' goods such as laborers could con- 
sume? This evidently at any particular time 
is very little subject to possible increase. If 
the wages fund theory be thought of as applying 
only to the market wages of the moment, or 
of a short season, it is obviously right in its 
assumption of a predetermined, possible total 
of wages. If, for instance, an aggressive 
trade-unionism could force an increase of money 
wages, there would, for a time, be no corre- 
sponding or considerable rise of real wages. 
If the increased funds needed to pay higher 
wages were made possible by an expansion of 
credit, the money and credit left to the class 
of employers generally for their personal use 



I40 PROFIT AND WAGES 

would not be diminished.* In any case, the 
capitaHst and employing classes would not 
diminish their consumption of necessaries but, 
if any economy became necessary, would exercise 
it by a decreased purchase of luxuries. With an 
increasing money demand for necessaries from 
the laboring class and no falling off of demand 
from other classes, prices of necessaries would 
rise and real wages to that extent would fail 
to increase. It appears, therefore, that if only 
the immediate results of a general rise of money 
wages, such as we have supposed, were to be 
considered, there would be no sufficient reason 
for calling the wages fund doctrine into question. 
If, however, a longer period of time be taken 
into view, it will appear that the greater profits 
gained by producers of necessaries would lead 
to a shifting of capital from the production 
of luxuries to that of necessaries and then the 
higher level of money wages, if still maintained, 
would mean a higher average of real wages. 
The higher scale of payment for labor would 
correspond to a larger wages fund but the 
increase of the fund would appear as the effect, 
and not as the cause, of the higher level of 
wages. Capital funds used to raise wages would 
have been created by credit expansion. That 
part of the real income of the capitalist class 
consisting of luxuries would have been dimin- 
ished. But all this can be thought of as happen- 

*Such aggressive and successful unionism, however, might 
cause a shrinkage of credit. 



THE DEMAND FOR LABOR 141 

ing only on the assumption that capitalists 
as a whole do not increase the quantity of 
money income spent for consumers' goods, 
or in other words, that they are content to 
consume fewer goods while saving as large a 
money fund for investment as before. Unless 
there is as much saved as before, capital and 
the wages fund will be diminished, and the 
general rise of wages will have been but a 
temporary one. 

With a very thrifty capitalist class, deter- 
mined never to lessen its annual saving, a 
general rise of wages at the expense of profit 
and of the current consumption of the rich, is 
conceivable. In a theoretical discussion it 
may be given some weight. But it should be 
noted that if this constitutes an objection to 
the wages fund theory, it is one of which most 
of the critics of that theory are debarred from 
making use. Holding, as they do, some form 
of the abstinence theory, they should argue 
that no permanent increase of the wages fund 
at the expense of profit and interest is possible. 

The theory which most gains support from 
the possibility of an increase of the total of 
real wages through aggressive labor organization 
is that which may be called the ''bargain 
theory" — the theory that the respective shares 
of capitalist and laborer depend on the outcome 
of a struggle between them. That this theory 
emphasizes an important factor in the making 
of actual wage scales, no one conversant with 



142 PROFIT AND WAGES 

the facts would deny. Whatever general theory 
of wages we come to accept, we must give some 
recognition to this factor, at least as supple- 
menting the main propositions of our theory. 
The present writer would hold, however, that 
the statement that wages are determined by 
a struggle or bargain, — the outcome of which 
is largely decided by the relative aggressiveness 
and obstinacy of the contending parties, — 
while true, does not carry analysis as far as 
it should be carried. Our theory should aim 
to note the effect of the resources and strategic 
positions of both parties on the issue of the 
struggle. Without such further development 
of the analysis, the positive contribution of the 
theory would be little more than a truism, 
while its negative implication that there is 
nothing more to be said, would be an evasion 
of all the difficulties of the problem. 

As our discussion has shown, the account 
given by the wages fund theory of how the 
general scale of wages is made, fails to allow 
for many disturbing factors. It is a very 
abstract doctrine and would need to be supple- 
mented and qualified extensively before it 
could be regarded as anything but a very rough 
approximation to reality. Why give it any 
thought at all if it falls so far short of giving a 
definite and accurate picture of industrial facts? 
The answer to this objection is that the wages 
fund theory gives what no other theory has 
given or can give — an explanation of the 



THE DEMAND FOR LABOR 143 

general wage level as distinguished from com- 
parative or particular wages. It is analogous 
to the so-called "quantity theory" of money 
or theory of the general price level, and as 
necessary to the explanation of actual wages 
as the quantity theory is to that of actual 
prices. The theory of particular or comparative 
wages, like the theory of relative prices of 
commodities, or, as it is ordinarily called, the 
theory of "value," presupposes a general level. 
Both of these theories of relative magnitude 
must assume a given fund or flow, the one a 
wages fund, the other a given quantum of 
money and credit. The problem in both cases 
is how the fund is divided up between particular 
values or prices. For the purposes of a general 
theory of distribution, however, we need to 
explain the absolute height of wages, not the 
comparative scale of payment of different classes 
of labor. In order to explain how the marginal 
product is divided between capital and labor, 
it is necessary to show not why one set of 
laborers get more than another but what 
determines either the average or the total of 
wages. Only on that basis can the share going 
to capital be accounted for. 

No theory other than that of the wages fund 
can properly be called a theory of general wages 
or of the general wage level. The subsistence 
theory, though contributing to the explanation 
of both general and relative wages, is con- 
fessedly incomplete and can serve, at best, 



144 PROFIT AND WAGES 

only as part of a complete explanation. The 
productivity theory, practically the only wage 
theory to have gained general acceptance, 
though professing to explain general wages, 
has unconsciously applied a method of reasoning 
permissible only to an explanation of particular 
wages. This aspect of current speculation on 
wages, and the productivity theory in general, 
must now be subjected to a critical examination. 

Although some assumptions in regard to 
the supply of labor must be pre-supposed, the 
productivity theory in its usual formulation 
is devoted entirely to an analysis of the forces 
on the side of demand. This one-sided emphasis 
has doubtless been favored by the Austrian 
theory of value with its analysis of demand 
as varying with the utility and price of the 
commodity demanded. Applied with great 
success to the elucidation of the value of con- 
sumers' goods, this theory of value was at 
once extended to producers' goods including 
labor. No questions were raised as to whether 
demand for labor might not differ radically 
from demand for consumers' goods. Labor 
was described as subject to a law of diminishing 
productivity homologous with the diminishing 
utility of the unit of an increasing quantity of 
a consumer's good, and its market value as 
determined by the utility, that is the pro- 
ductivity, of the marginal unit, to the buyer. 

Now this description of demand for labor 
as of altogether the same nature as that for 



THE DEMAND FOR LABOR 145 

consumable commodities, leads to an erroneous 
conception of the demand as almost indefinitely 
extensible. Demand for a consumption good 
means the offer of a part only of the purchasing 
power in the hands of the consumer, the total 
being distributed among a large number of 
consumable commodities. Demand for any 
of these goods can be almost indefinitely in- 
creased by abstaining from or diminishing the 
purchase of other goods. If good A rises in 
utility as compared with B, C and D, the 
demand for it increases while that for B, C and 
D falls off. Demand for labor, viewing it 
collectively and not from the point of view of 
one industry or of a single industrial establish- 
ment, is limited by the total of funds destined 
for the payment of wages. These funds, how- 
ever, instead of being assigned to the purchase 
of a vast variety of things, as are consumers' 
funds, are intended for the purchase of labor 
alone. There is no choice between different 
goods with the possibility of increasing demand 
for any of them by withdrawing funds from the 
purchase of the others. Entrepreneurs may 
choose between the production of a great diver- 
sity of goods but whatever their choice, it 
involves the purchase of labor, the universal 
requisite of the productive process. In the 
use of the wages fund they have no choice 
between different things but only between 
different uses of the same thing. 



146 PROFIT AND WAGES 

In short, there is a fund all of which must be 
invested and the size of which is an important 
determinant of the level of prices paid for labor. 
It is distributed as wages among different grades 
of work in such manner as to tend towards an 
equality in the marginal rate of profit. Such a 
distribution of the fund makes the wages of 
different kinds of labor vary according to their 
marginal productivity. But it would be an 
error to leap to the conclusion that, because 
comparative wages are graded according to 
productivity, wages are equal to the marginal 
product of labor (or the marginal product 
discounted) and that productivity directly deter- 
mines the absolute as well as the relative scale 
of payment.* Productivity may be appealed 
to for the purpose of explaining comparative 
rates of remuneration only. As a theory of 
relative wages, the productivity theory may be 
accepted as, at least, a fairly satisfactory partial 
explanation of existing wage scales. Its pretense 
to a valid explanation of general wages, however, 
must be rejected. The absolute scale of pay- 
ment, the general level, can be explained only 
by a reference to the total of purchasing power 
directed to the employment of labor. 

This brings us back to the wages fund theory. 
We may regret that it seems vague and exces- 
sively abstract, — that only by admitting exten- 

*This is the error of a considerable part of the attempted statis- 
tical verification of the productivity theory by Professor 
Moore {Laws of Wages, especially in Chapters IV and VI). 



THE DEMAND FOR LABOR 147 

sive qualifications and exceptions, it can be 
made to appear as an approximately accurate 
picture of reality. The aim of economic thought, 
however, should be to specify and formulate as 
accurately as possible the various qualifying 
propositions which are to be made, but to treat 
these as developments or modifications of the 
wages fund doctrine, not as grounds for rejecting 
it in toto. The attitude of a large number of 
economists towards the quantity theory of 
money might well indicate the treatment which 
should have been, but was not, accorded to 
the wages fund doctrine. Various efforts at 
precise statement of all the factors determining 
the general price level have given us something 
much more complicated and perplexing than 
the bold and crude quantity theory of an 
earlier time. But for all these developments 
of the theory, there is, on the whole, little 
disposition to deny that the existing quantum 
of money is one of the most important factors 
in making the scale of prices, and that the 
quantity theory needs to be perfected, not 
rejected. 

The objections raised above to the productiv- 
ity theory may be made somewhat clearer by 
diagrams. These, it may be remarked, will 
aid us in our constructive as well as in our 
critical task. In Figure I a fixed supply of 
labor {ah) is assumed, a condition conceivable 
as true for short periods; in Figure II a varia- 
ble supply with an increasing supply price 



PROFIT AND WAGES 



represented by an ascending supply curve. Since 
the productivity theory regards wages as deter- 
mined by marginal productivity and the location 
of the margin depends on the number of laborers 
employed, some assumptions must be made 
in regard to supply. The two most probable 
cases are given and they are not such as could 
in reason be objected to by adherents of the 
productivity theory. To simplify the problem 
it is assumed that there is only one grade of 
labor. As usual distance along the abscissa 
or base line represents supply or nimibers of 
laborers. The distance of points on the curve 
ec from the base line represents productivity. 




Figure I Figure II 

Now the productivity theorist would assume 
that the productivity curve ec may be regarded 
as a demand curve, representing what employers 
could pay without loss for different quantities 
of labor. Under the given conditions of supply 
they would hold that the price per unit of labor 



THE DEMAND FOR LABOR 149 

would come to equal ^c* But at this point 
there has crept in the common error that what 
is possible for one or for a few, is possible for 
all. An individual employer could pay labor 
what it produces at the margin (discounted). 
If his capital was insufficient for this outlay, 
he could borrow. But the totality of employers 
could not do this unless the total funds available 
for the payment of wages equalled marginal 
product per unit of labor multiplied by the 
whole number of units employed. In other 
words the collective wages fund would need 
to be equal to what is represented by the 
rectangle ahcd in each diagram. If it were 
less than this, — if, for instance, it equalled 
the shaded portion of each diagram, the rate 
of payment per unit of labor would be indicated 
by the width of this shaded strip {hh' in Figure 
1, fg in Figure II). It could not be more than 
that but would tend to equal all of it. 

There is an assumption underlying the pro- 
ductivity theory that wages are paid out of 
current product; in other words, that the 
labor of a given week or month is paid out of 
the product of that week or month. If that 
assumption were valid, labor's productivity 
would create the fund out of which it is paid 

*If we assume that employers would not in any case pay more 
than the discounted value of the product as wages, the curve 
ec could be taken to represent discounted value of product. 
If it represents full value of product, then the wages per unit 
of labor would be something less than cb, and in the case 
illustrated by Figure II something less than ab of labor would 
be employed. 



I50 PROFIT AND WAGES 

and it would be quite possible to pay labor the 
full equivalent of its product. But if we look, 
not at the money funds involved, but at real 
income, it is obvious that the larger part of 
the current product consists of unfinished goods, 
or what Bohm-Bawerk would call "future 
goods;" and that the consumable wealth of 
which the real wages of labor consist is, for the 
most part, the product of labor performed 
weeks or months ago. The notion that wages 
could be paid out of current product grew in 
part out of the onslaught made on a misunder- 
stood wages fund doctrine. The misconception, 
already referred to in this chapter, of the wages 
fund as consisting of money or a sum of value 
expressed in terms of money, suggested that by 
means of credit the cash proceeds from the sale 
of current product could be anticipated and 
used to pay current wages. With less anxiety 
to have done with the wages fund theory, and a 
clearer general view of the production and dis- 
tribution of real as distinguished from money 
income, of the relation of past to present and 
future in the continuous flow of products, 
economic theory might have kept a better 
perspective and a stronger grasp on the funda- 
mental factors. 

Confusion also grew out of the unfortunate 
tendency to look at things too exclusively from 
the point of view of an individual employer or 
business. It brought into the mental fore- 
ground the individual employer's estimate of 



THE DEMAND FOR LABOR 151 

what wages he could pay as dependent on the 

anticipated value of the product, but failed to 

place in strong relief the important fact that 

collectively capitalists and employers could 

not or would not advance in wages more than 

what they had saved out of past product and 

destined for investment. 

Now let us return to the consideration of 

our diagrams in order to examine certain 

objections which might occur to the reader. 

The difference between the wage and the 

marginal product constitutes the profit of capital, 

equal in Figure I to ch' and in Figure II to the 

extension of fg necessary to reach the curve 

ec* The rate of profit as indicated in Figure 

cb' 
I would be . Owing to the mobility of cap- 



ital, always cheerfully taken for granted in 
economic theory, there would be a tendency 
towards the same marginal rate throughout 
the entire industrial field, and wages every- 
where would tend to equal the marginal product 
discounted by the prevailing rate of profit. 

As a statement of what wages equal, of the 
amount of wages, this is in agreement with the 
productivity theory. Not, however, as a formu- 
lation of the process by which wages are deter- 
mined. Our argument shows wages to be 
determined, not by the productivity of labor 

*Assuming that the curve ec represents the full, not a discounted, 
value of the product — an assumption we make from this 
point on. 



152 PROFIT AND WAGES 

and an independently established rate of dis- 
count, as the productivity theorist would hold, 
but by the wages fund and the number of 
laborers, under the conditions given in Figure I; 
and by the wages fund and the supply prices 
of labor, under the conditions of Figure II. 
Profit is shown to be a residual left after wages 
are paid, and the rate of profit the result, and 
not a cause, of the scale of wages. 

Adherents of the abstinence and time-prefer- 
ence theories, however, would hold that the 
prevailing rate of profit (at least under static 
conditions) is a necessary rate determined by 
cost of abstinence or waiting, or by the rate 
of time-preference or something of that sort. 
If the rate of profit were more than this, they 
might argue, there would be an increase of 
capital, that is, of the wages fund, and a con- 
sequent rise of wages until the diminished 
rate of profit was no longer sufficient to cause 
any further increase of capital. Then wages 
would be equal to marginal product discounted 
according to an independently determined rate 
of discount (a rate determined by subjective 
factors) . Product and the rate of discount would 
appear to be the two determinants of wages 
and we should apparently have reached the 
productivity theory of wages now most in favor. 
It should be noted, however, that the degree 
of marginal productivity of labor is not, in this 
way, proved to be the direct and immediate 
determinant of wages which the prevailing 



THE DEMAND FOR LABOR 153 

theory seems to consider it, but acts through 
the amount of accumulation of capital which 
it makes possible. If, for instance, there were 
a general increase of productive power — which 
could be represented diagrammatically by a 
productivity curve drawn at a greater distance 
from the horizontal base line — wages would 
not rise until the higher profits had resulted in 
an increase of capital with which to pay wages. 
The strongest objection, however, to regarding 
wages as determined by the discounted marginal 
product, is the consideration that the rate of 
discount cannot enter into the determination 
of wages as an independent factor but is itself 
determined by the prevailing price of labor. 
It is not true that capital must grow until there 
results a necessary rate of profit which makes 
further increase of capital impossible. There 
is probably no rate so small as to stop altogether 
the further growth of capital. The largest 
accumulations are made out of the differential 
gains of earlier, or intramarginal investments, 
and are not much affected by the decreasing 
rate of gain left to additional supplies of capital. 
Some saving would occur if there were no interest 
or profit at all, and capital once accumulated 
is not willingly consumed. In any case, as 
shown in the chapter on the abstinence theory, 
the great forces determining the supply of 
capital and thereby the marginal rate of return, 
have very little connection with the dubious 



154 PROFIT AND WAGES 

and uncertain subjective factors emphasized 
by the abstinence and time-preference theories. 

No general and simple explanation of what 
makes the total of capital or of the wages fund 
is possible. The theory of distribution, therefore, 
must rest satisfied to assume the given amount 
of capital as one of its data. As to wages, we 
may say that the wages fund and the factors 
regulating the supply of labor are the chief 
determinants. Productivity plays no part except 
for its permissive influence on the accumulation 
of capital. Marginal productivity has but 
a small share in this indirect influence on wages 
because most capital is acciimulated out of 
earlier or intramarginal investments. As to 
the rate of discount, that cannot be thought of 
as determined independently of wages. What- 
ever tenuous connection may exist between it 
and the subjective conditions of saver and 
investor, its most important direct determinant 
is the wage level. It is an effect, not a cause 
of the scale of remuneration for labor. 

As an explanation of general wages the 
productivity theory should be unreservedly 
rejected. It has the fundamental defect, as 
we have seen, of treating demand for labor as 
homologous with demand for particular con- 
sumers' goods. As a theory of the comparative 
scale of pa5Ament of different employments 
and grades of labor, however, it is entitled to 
consideration. Possibly the failure of the classi- 
cal school to set forth clearly the part which 



THE DEMAND FOR LABOR 155 

relative productivity plays in grading particular 
wages, may be one reason why the factor of 
productivity in the end was assigned a part 
of greater importance than is properly due to 
it in the theory of both general and particular 
wages. That the wages fund theory, being an 
explanation of average wages or the general 
wage level only, left unexplained the difference 
in payment between various occupations, was 
obvious enough to the classical writers. Unfor- 
tunately, however, their treatment of particular 
wages, a problem of inferior theoretical interest, 
was somewhat perfunctory, and was likely 
to be no more than a repetition of some obser- 
vations made by Adam Smith.* Meanwhile 
superficial and optimistic impressions of the 
effect of increasing productivity on the earnings 
of labor, together with the shifting of the view 
point of economic reasoning by the so-called 
Austrian school, have given the productivity 
theory a position of unmerited security. 

Of course it has not altogether escaped the 
fate of all economic theories of being called 
into question and denounced as fallacious. 
The usual point of attack, however, has not 
been that chosen in the preceding pages, but 
one suggested by the apparent practical dif- 
ficulties of ascertaining marginal productivity.* 

*Cannan, Production and Distribution, 1 776-1 848, p. 364. 

**See especially Arturo Labriola, Distribuzione del dividendo e 
produltivita tnarginali; Com^lissen, Theorie du salaire, and 
two articles by Richard SchuUer in the Archiv filr Sozial- 
wissensckaft, July and November, 191 1. Schiiller's discussion 



156 PROFIT AND WAGES 

Can and does an employer estimate the 
marginal productivity of labor, either of that 
which he employs or of labor in general? It 
must be confessed that the problem looks 
somewhat puzzling. What, for instance, is 
the size of the marginal unit? Is it one man or 
a group of men? The increment of product 
due to the last of one hundred men taken on, 
would be less than the average product per 
man of the group of hundred men. How can 
one know what value to impute to each of 
several grades of labor associated in varying 
proportions in the production of different com- 
modities and in different industries? The 
doctors disagree in regard to the laws of "impu- 
tation." But even if we may accept one of the 
formulations offered, does it not require the 
eye of faith to detect the operation of any such 
law in the actual world? Does not the fact that 
the employer usually estimates, not the product 
of the individual laborer or of a group of laborers, 
but what he calls his "labor cost," make the 
utilitarian calculus applied to the purchase of 
labor appear somewhat unreal? 

However, labor cost is a function of pro- 
ductivity, and thus indirectly the productivity 
of labor enters into the employer's estimates 
of the advantage of hiring labor. In fact all 

is especially suggestive because of its concrete and pains- 
taking character. The best known criticism in the English 
language is probably that by Hobson. See " The Industrial 
System," p. 112 flf. See also an article by W. M. Adriance in 
the Quarterly Journal of Economics, November, 1904. 



THE DEMAND FOR LABOR 157 

of the difficulties raised by the critics only 
indicate that in the real world, in place of the 
precise calculations attributed to the employer 
by the productivity theory, we find only guess 
work, and rough approximations of what is 
profitable. It is not proved that as a formu- 
lation of tendencies, of points of equilibrium 
towards which economic forces work, the cal- 
culus of the productivity theory may not be 
accepted. The real weakness of that theory 
lies, as we have seen, in the assimiption that 
employers are able and somehow willing to pay 
either the full value of the marginal product, or 
this value discounted according to some inde- 
pendently established rate of discount. As an 
account of what makes the comparative scales 
of remuneration for labor the theory may pass 
muster. It does not give an acceptable explana- 
tion of the absolute earnings of labor, that is 
of the general level or average of wages. 

This concludes our critical examination of 
wage theories. Its primary purpose was con- 
structive, and to the attentive reader the positive 
results are already apparent. Stated briefly 
the theory to which our discussion has led us, 
is the wages fund doctrine modified by the 
conception of a flexible supply of labor with 
a gradually rising scale of supply prices. The 
assumption of a temporarily fixed number of 
laborers made by the classical exponents of 
the wages fund theory, is no longer tenable. 



158 PROFIT AND WAGES 

because of the part played by immigration in 
the labor markets of all the great industrial 
areas. The conditions determining wages today 
are those indicated by Figure II (Page 148). 
If the lower curve be taken to indicate the 
supply prices of labor, rising as the quantity 
of labor is to be increased, and determined 
chiefly by conditions outside of the capitalistic 
regions of the world and by the expenses and 
hardships of emigration — then an increasing 
wages fund will be divided, not among a station- 
ary number of workers, but among a supply of 
laborers increased by immigration. 

For the lowest grades of unskilled labor, 
the prices necessary to attract an increasing 
number probably rise very slowly. The supply 
curve might properly be drawn so as to run 
almost parallel with the horizontal base line 
for a large part of its course. In that case, 
the supply price would be the chief determinant 
of wages and an increasing wages fund would 
result in an increased number of employes in 
capitalistic industry rather than in a rise of 
wages. At some point, however, the curve 
would begin to turn upwards. Our simplest 
formula must be that the size of the wages 
fund, or the supply of capital as we conceive 
it, together with the supply prices of different 
quantities of labor, determine the general level 
of wages. 



CHAPTER IX 

CONCLUSION 

To gather up the results of our inquiry, the 
outHne of the problem of distribution given in 
Chapter I may be recalled. The first stage in 
the analysis was that of the division of product 
between landowner and entrepreneur. It was 
pointed out that where there is product in 
excess of the marginal rate of productivity, this 
surplus must fall to the landowner, — unless, 
as the result of superior luck and ability, it 
takes the form of a differential profit. The 
second stage of the problem was the determina- 
tion of the rate of profit, profit including both 
the income of the entrepreneur (exclusive of 
any differential gain he may obtain) and that 
of the capitalist. This rate of profit, however, 
depends on the division of the marginal product 
between entrepreneur and laborer, and the 
problem, therefore, becomes that of finding 
both a theory of profit and of wages. The 
character and the terms of the division between 
capital and labor constitute the most contro- 
versial matter in the whole theory of distribu- 
tion. That, however, it is a question of dividing 
a marginal product, the margin being thought 
of as both an intensive and an extensive land 



i6o PROFIT AND WAGES 

margin, has come very near being generally 
accepted.* 

There are, however, certain ideas which have 
obtained some currency, but which cannot be 
fitted into this formulation of the problem, and 
to these we must now advert for a moment. 
First, we may take note of a disposition to 
bring land under the concept of capital, making 
rent appear as a part of the share known as 
interest. The objection to be made to this 
conception is that the total supply of land 
cannot be increased by saving, or indeed, by 
any practicable means. As the amount of 
capital is obviously a determinant of the rate 
of interest, and in all of its forms other than 
that of land, can be increased by saving, land, 
though defined as capital, is left standing 
outside of the formulation of the important 
factors determining the income of capital. 
Additional reasons for declining to subsume 
land under capital can be found in all the 
considerations advanced in favor of viewing 
capital as subsistence advanced to labor. 

We may note next the theory which, pro- 
ceeding apparently on the assumption that land 
is variable in quantity, regards its rate of 
return as determined by the specific product 

*We need not consider at length the views of those who deny 
the existence of no-rent land. Provided rent as a return above 
that on an intensive margin is recognized, that is provided the 
concept of a margin is accepted, there is no substantial departure 
from the formulation of the problem of distribution upon which 
our discussion is based. 



CONCLUSION i6i 

of its marginal increment. It is not opposed 
to the conception of land rent as a differential 
gain, but refuses to consider this differential 
character as anything distinctive. Wages and 
interest, it is argued, may also be viewed as 
of the nature of ''rents." Add successive 
"doses" of any of the three factors of production, 
— land, labor, and capital, — to a fixed quantum 
of the other two. Its rate of return will then 
be established by the addition to total product 
made by the last dose, while the differential 
or excess of the earlier or intra-marginal doses, 
falls as a "rent" to the other two factors, those 
thought of as fixed for the time being, and as 
being dosed by the factor in question. Each 
share in distribution can thus be made to appear 
both as a marginal return and as a rent. 

This "law of the three rents" is, of course, 
a complicated form of specific productivity 
theory and the difficulty, already confronting 
this theory, of demonstrating a specific product 
for labor and one for capital, is greatly aug- 
mented when it becomes necessary to impute 
something to a third factor.* All the objections 
which may be made to the specific productivity 
theory may be made against this variant of 
the theory. Furthermore, as land is often fixed 

*To add a fourth factor, the services of the entrepreneur, and 
to think of this as appHed in doses and rewarded according 
to its marginal productivity, does not increase the difficulties 
of an already overtaxed theory of imputation, but is open to 
other objections. See Edgeworth, "The Theory of Distri- 
bution," Quarterly Journal of Economics, February, 1904. 



i62 PROFIT AND WAGES 

in quantity and almost never capable of con- 
siderable increase, except in the form of no- 
rent land, the variability of this "factor of 
production" assumed by the "law of the three 
rents," is in conflict with facts which the 
economists may not disregard. Of course, a 
particular establishment or industry may secure 
additional amounts of rent -bearing land. It 
can do this if it can extract a larger return from 
the increments of land in question than was 
obtained in the enterprises from which the 
land was withdrawn. In other words, advan- 
tageous rearrangements of productive forces 
are possible. Such changes, however, have 
nothing to do with the shifting of the entire 
productive margin which the specific produc- 
tivity theory pictures as resulting from increased 
or decreased supply of a factor of production. 
Unless the total supply of rent bearing land is 
capable of considerable increase, the dosing 
principle of determining a specific rate of 
return is not applicable to land. The total 
supply being practically fixed, the return to 
the landowner must necessarily take the form 
of a differential gain, of a product in excess of 
that resulting from the marginal investment 
of the variable factors of production. It is 
only by falling into the all too common vice 
of regarding the problem of industry from the 
point of view of one particular business unit, 
that one can reach the mystic doctrine of the 
Trinity of Rents. 



CONCLUSION 163 

To return to our fundamental assumption 
that it is a marginal product which is to be 
divided between capital and labor, we found 
that the various attempts at a solution of 
this controversial problem, may be grouped 
under three heads. In other words, three 
methods have been tried in the attempt to 
account for the terms of the division of product 
between capital and labor. First, an inde- 
pendent explanation of one share, either wages 
or profit, the other being treated as a residual. 
Second, an independent explanation of each, 
but the two covering the entire marginal 
product — the productivity theory. Third, the 
assertion that the division of the product be- 
tween labor and capital is the outcome of a 
struggle — the bargain theory. 

Commenting on these in reversed order, we 
may say that the bargain theory virtually 
gives up the problem. There is a struggle 
between employer and laborer, and the com- 
parative aggressiveness and obstinacy of the 
contestants may largely determine the out- 
come. The problem for the economist, however, 
is to define the strategic points on which the 
contestants base their demands. What alterna- 
tive has each party in mind when refusing 
the terms of the other? To call the process of 
distribution a bargain or a struggle may be 
unobjectionable terminology, but does not ex- 
plain its results. 



i64 PROFIT AND WAGES 

The second of the three methods of explaining 
distribution, the productivity theory, is open to 
various objections which need not be repeated 
at this point. There is left to us, therefore, 
only the method of proving either the laborer, 
or the employer to be a residual claimant. This 
is impossible in the case of the laborer because 
the return to capitalist and employer cannot 
be explained independently of the wage earner's 
share. The time-preference and abstinence 
theories cannot account for the rate of return 
for capital except by imposing a fiction on our 
minds. There remains, therefore, as the only 
apparent solution, the demonstration of the 
scale of wages as independent of the size of the 
product and of the share going to capital. 
The explanation of wages propounded in the 
chapter preceding this, the wages fund theory 
supplemented by a theory of the supply price 
of labor, satisfies these requirements and makes 
it possible to represent profit of capital as a 
residual income. 

The conclusions reached carry us back to 
doctrines of the classical school. They include 
the classical concept of profit of capital, in 
place of the later notion of profit and interest 
as independent shares; a residual claimant 
theory of this profit not differing greatly from 
Ricardo's; and the wages fund theory. 

It would, of course, be absurd to insist that 
the last word on all questions of distribution 



CONCLUSION i6s 

is to be found in the pages of the classical 
school. Much remains to be corrected or 
elaborated. But the strategic points of attack 
on fundamental problems were more clearly 
perceived by Ricardo and his generation than 
by the majority of their successors. Not 
given to academic refinements and subtleties, 
nor led by radical attacks on property to bend 
scientific inquiry in the direction of an apolo- 
getic of capitalism, their thought moved directly 
and with single aim upon the significant and 
fundamental features of the industrial system 
before them. So far as later developments 
shift the point of view which must be taken 
by the theory of distribution, the most sig- 
nificant is the large international movement 
of capital and labor. The part played by immi- 
grant workers in the advanced industrial areas 
of today makes it necessary to look beyond 
the narrow national boundaries of the labor 
market as conceived by the earlier economists. 
In our theory of the supply price of labor, 
recognition has been given to these changed 
conditions. Other products of economic evolu- 
tion it has not been necessary to examine. 
The growth of corporations and the increasing 
complexity of what Veblen would group as 
"pecuniary employments" have opened fields 
for investigation scarcely thought of by the 
classical economists. The analysis of these 
developments, however, is not an essential 
part of the "first approximation," the general 



1 66 PROFIT AND WAGES 

and fundamental theory aimed at in the pre- 
ceding pages. For the same reason we may 
decHne to discuss the problem of monopoly 
gains. In the search for a satisfactory funda- 
mental theory without which the details of 
an inquiry into the capitalistic processes of 
these latter days are without meaning, the 
classical thinkers are still our best guides. The 
very fact that they are free from the perplexities 
of later developments in theory and practice, 
makes them a valuable propaedeutic to the 
study of the problems of our time. But this 
praise is only for their scientific work, their 
unbiased analysis of things as they are. Their 
political ideals and attitude towards social 
reform have less significance to our generation 
and, in any case, are irrelevant to the present 
inquiry. 

The considerations which have led us to 
reject a large part of the fruits of more recent 
theory, are stated at length in the critical 
passages of the preceding chapters. It will 
not be necessary to recapitulate them at this 
point. Let us rather take note of certain 
general tendencies which manifest themselves 
in almost all of the errors into which modem 
theory has fallen. 

First, there is the excessive rationalism of 
the utilitarian calculus, whose pedigree may 
be traced to Bentham, but whose greatest 
vogue has come through the influence of the 
so-called Austrian school. It culminates in the 



CONCLUSION 167 

time-preference theory and in some of its 
phases is not free from the suspicion of an 
apologetical Tendenz. As we have seen, it 
attributes to savers and investors, feats of 
calculation of subjective costs and gains which 
are utterly impossible to mortal man. A 
psychological turn of very questionable advan- 
tage was thus given to the theory of distribution. 
It seems indeed doubtful whether psychology 
will ever make a positive contribution to the 
explanation of how the real income of society 
is distributed. In any case, the application 
of a crude, hedonistic psychology to the problem 
was a misfortune. 

Another unfortunate tendency in modem 
economics is the consideration of the problem 
of distribution as essentially included in the 
general theory of value. There are, of course, 
analogies between the purchase and sale of 
consumers' goods (the proper theme of the 
theory of value in economic literature) and the 
purchase and sale of the services of the "factors 
of production." But the problem in the two 
cases is not identical. To the theory of value, 
commodities appear as competing for the con- 
sumer's favor. Even monopoly products com- 
pete because the competition referred to is 
not that between different sellers of the same 
commodity, but that between different com- 
modities. The problem of value, in other 
words, is that of the relative prices of goods, — 
of the proportionate amounts of money and 



i68 PROFIT AND WAGES 

credit in the hands of the consumers assigned 
to the purchase of each commodity. 

Now can this way of looking at the matter 
explain the remuneration of the factors of 
production? In trying to develop the analogy 
the entrepreneur must evidently be assigned 
the role played by the consumer in the theory 
of value. Can he choose, as the productivity 
theories represent him, between different 
"factors of production;" as the consumer 
chooses between different consumable goods? 
If, for the sake of argument, we accept the 
idea of capital as consisting of "intermediate 
goods," we have three factors of production 
which the entrepreneur may purchase.* He 
needs all three, though the proportions in which 
he takes them might vary. So far the analogy 
holds between demand for factors of production 
and that for consumers' goods, though there 
are only three of these so-called factors, while 
consumable goods are numbered by the thou- 
sand. When, however, we look at the side of 
supply, important differences appear. If any 
factor is insufficiently rewarded it cannot change 
into some better remunerated factor. If, on 

*The problem becomes very perplexing when the entrepreneur's 
function is represented as a fourth factor of production. It 
is something not purchased by the entrepreneur but by the 
consumers of the products of industry, and, therefore, does 
not compete with the other three factors for the favor of the 
same set of possible purchasers. 



CONCLUSION 169 

the contrary, commodity A cannot command 
a satisfactory price, its producers can turn to 
the production of commodities B, C, or D. 
The insufficiently remunerated factor of pro- 
duction may not even have its supply dimin- 
ished. We have seen that in the case of capital 
there is likely to be no decrease in the total 
supply, but only a slackening in the rate of 
increase. In the case of labor the process of 
decreasing supply, that is of lowering population, 
is extremely slow. In the case of land there 
is no possibility of diminishing supply. 

Let us return now to the question of demand 
for the factors of production. The analogy 
between the remuneration of the factors of 
production, and the payment of prices for 
consumers' goods, vanishes utterly when we 
reject the conception of capital as consisting 
of intermediate goods. There are reasons for 
regarding capital as simply the means of pay- 
ment for hired labor. Use of capital means 
employment of labor. There is no choosing 
between labor and capital for the employer. 
He buys labor by means of capital. The choice 
apparently existing between the purchase of 
labor and of "capital goods" is really a choice 
between different kinds of labor. Instead of 
having three factors to choose from, the entre- 
preneur, therefore, appears to have only two. 

But, if we grant the existence of no-rent 
land and no-rent margins, we have the possibility 



lyo PROFIT AND WAGES 

of dispensing with the payment of a price for 
the use of land. Then there remains but one 
thing to buy for the entrepreneur, and that is 
labor. The entrepreneur (and the capitalist 
acting through the entrepreneur) must buy 
labor and it can be bought of the laborer only. 
The laborer, in his turn, ' must sell his labor, 
and it can be sold to the entrepreneur only. 
Instead of competing factors getting a price 
from a common purchaser, the process of 
distribution becomes a bargaining between two 
social classes. Both of them must ultimately 
come to terms, although the compelling forces 
on the two sides may be of very unequal urgency. 
Such a bargain may be covered by a very general 
and abstract theory of value and exchange, 
but all the really significant and interesting 
features disappear under such treatment. The 
attempt to approximate the theory of distri- 
bution to the more specialized theory of the 
values of commodities can only lead to con- 
fusion, and should be abandoned. 

Like the excessively rationalistic, psycho- 
logical character of modern economics, the 
tendency to confuse the problem of distribution 
and that of value, is also largely to be attributed 
to the influence of the Austrian theory of value. 
The enthusiasm with which the latter was 
received caused the ready acceptance of the 
analogous reasoning of the productivity theory. 



CONCLUSION 171 

Indeed, the modern theorist felt most at ease 
when speculating on the subject of value. 
Every question in economics had perforce to 
be haled into this field. For the theory of 
distribution, however, the outcome was a dis- 
torted perspective and a failure to grasp the 
significant elements of the problem. 




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